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Deciding between refinancing your car loan and mortgage takes some extra consideration.
When you have multiple types of loans, it can be difficult to decide which one to prioritize. This decision becomes increasingly important when you have the opportunity to refinance your mortgage or car loan (or both).
While it would be nice to refinance both your auto loan and mortgage at the same time, doing so might not be practical. Refinancing one loan could hurt your chances of qualifying for decent rates on the other. But sometimes, it can actually help your next credit application.
Here’s what you need to know when deciding between refinancing your car loan or mortgage first.
Why Refinance a Car Loan or Mortgage?
Refinancing means using a new loan to pay off an old one, usually with a new lender. You may also get a different loan term, interest rate, or monthly payment.
Nearly any type of loan can be refinanced including auto loans, mortgages, student loans, and personal loans. There is no set limit on how many times you can refinance, and you can often refinance as soon as one month after taking out the initial loan.
Why would anyone need to refinance a loan? There are several reasons.
Maybe the original loan is more expensive than you’d like it to be. By refinancing, you can get a new loan with a lower interest rate or monthly payment. The refinance savings for both car loans and mortgages can be significant. Here are some recent stats:
- In 2020, 42% of borrowers saved more than $1,000 per year after refinancing their car loans.
- Borrowers who refinanced their 30-year fixed-rate mortgage for a new 30-year loan saved over $2,800 in principal and interest payments annually, according to a Freddie Mac study.
It’s easy to see why someone would want to refinance both.
Transfer a Title
Others refinance to take advantage of the positive equity in their home. This is much more common when refinancing mortgages and less so for cars.
A cash-out refinance is when you get out a loan for an amount greater than your loan balance and keep the difference, your property’s equity. The downside with a cash-out refinance is you end up with less equity in your property. That means if you were to sell in the near future, you’d miss out on cash from the sale.
Shorten or Extend Loan Term
When refinancing, you don’t necessarily need to stick to your same loan term. In fact, you can often score a better interest rate if you choose a shorter loan term. You can also lengthen your loan term, but doing that could lead you to actually end up paying more in interest over time. If you extend an auto loan, you also risk becoming upside down on your loan.
Change Loan Type
Similarly, if you’re unhappy with your current loan type, you can refinance and get a new loan with the terms that you want. For example, if you’re an adjustable-rate or balloon loan, you can refinance into a fixed-rate loan.
What’s the Difference Between Car Loan Refinancing and Mortgage Refinancing?
While the idea of refinancing is the same for vehicles and homes, they are two different loan products. Here’s why.
- Asset value: Simply put, mortgages are much larger than car loans. In 2020, the average individual mortgage debt was $208,185. Compare that to the average auto loan balance when refinancing in 2020, $21,667.
- Asset age: Lenders often won’t refinance a vehicle older than 12 model years. There generally aren’t any age limits for homes. They just need to meet minimum property standards.
- Term length: Home loans typically range anywhere from 10 to 30 years whereas car loan terms range from 24 to 84 months.
- Interest rates: While mortgage and auto refinance rates are impacted by some of the same factors, such as Fed rate drops, lenders may not necessarily offer the same annual percentage rate (APR) for both loan products.
- Amortization: While both are amortized loans, how interest is calculated and paid off may differ depending on the agreement. Car loans are typically simple-interest loans with fixed installments, as are fixed-rate mortgages. However, adjustable-rate mortgages and balloon loans are not that uncommon.
Now, let’s take a look at how lenders evaluate your applications for each.
Qualifying for Refinancing: Car Loan vs. Mortgage
The big question is: Can you pay back the loan as agreed?
Lending is all about risk. The larger amount of money you want to borrow, the riskier the loan is for the bank or credit union fronting the money on your behalf.
Every bank and credit union will have their own underwriting guidelines that determine which borrowers can be approved for a loan and at what terms. (This is why it’s important to shop around for rates.)
For pretty much any type of credit application, lenders will look at your:
- Income: Pay stubs, tax statements, employment history
- Debt: Car loans, mortgage, student loans, credit cards
- Credit: Payment history, credit limits, available credit
Lenders will also want to know the following information for a car or home loan:
- Down payment: How much are you paying toward the asset?
- Appraisal: How much is the asset worth? Is it in good condition?
- Loan value: How much do you need to borrow?
They may also ask for other information, but in general, that’s what you can expect when they evaluate your application.
But there are two very important differences when it comes to refinancing car loans and mortgages: your debt-to-income ratio and the appraisal process.
(DTI) Debt-to-Income Ratio Calculator
What is your monthly income?
What's your total monthly debt payments?
Debt-To-Income Ratios for Refinance Loans
When applying for refinancing, one of the most important factors is the debt-to-income ratio, which is your monthly debt payments divided by your monthly gross income.
Most mortgage refinancing providers have a maximum DTI of 43%. However, the maximum DTI for auto loan refinancing is closer to 50%. (The State of Auto Refinance report found that the average DTI for approved applicants was 29.1% in 2020.)
This difference in debt-to-income ratio can make or break your ability to get approved for one or both types of loans.
Home Appraisal vs. Vehicle Bookout
Both types of refinancing involve an appraisal which will determine the current market value of the property.
The appraised value of your home or car is important because it’s used in calculating your loan-to-value ratio, or LTV. It’s a percentage calculated comparing your loan balance to the property’s value.
To lenders, a lower loan-to-value ratio poses less risk to them. Because you owe less on your loan than the car or home is worth, that positive equity makes it easier to recoup any potential losses (e.g. foreclosure, repossession).
Car (LTV) Loan-to-Value Calculator
Appraising a home for mortgage refinancing
A home appraisal for mortgage refinancing often, but not always, requires an appraisal. If you’re planning on changing your loan term or cash out, you most certainly will need one to refinance.
An independent appraiser will visit your home and look at the interior and exterior to determine the value. Your lender will use the appraiser’s professional assessment to determine your refinance loan terms. You often have to pay for the home appraisal upfront. The appraisal can cost several hundred dollars which you’ll have to pay even if you don’t end up refinancing the home.
Depending on the type of mortgage refinance loan (conventional, cash out, jumbo, etc.), lenders may require 20% equity, or an LTV of 80%. Anything above and you could end up paying higher fees in addition to mortgage insurance — potentially eliminating any financial benefit of refinancing.
Appraising a vehicle for auto loan refinancing
When refinancing an auto loan, the appraisal process is referred to as a bookout and does not require an in-person inspection. Instead, you provide your lender details about your vehicle including your VIN, mileage, and current condition. They’ll compare that with your car’s retail value to get your LTV. You’re typically not charged any fees for the bookout.
LTV requirements for car loan refinancing are way different than mortgage refinancing. Because of the way vehicles depreciate (whereas homes typically go up in value over time), it’s not unusual to be upside down on a car loan.
The maximum LTV is 125% to 135%, sometimes higher if the borrower’s credit is stellar. The opposite is true too: If your credit score is too low, your lender may require an LTV closer to 80% or 90% or a down payment to bring the LTV down to an acceptable range.
|Differences Between Refinancing Your Car Loan and Mortgage|
|Max. debt-to-income ratio||50% DTI||43%|
|Max. loan-to-value ratio||125% LTV||80%|
|Cost to Refinance||$300 to $500+*||2% to 6% of total loan*|
Car Loan vs. Mortgage: Which Loan Should I Refinance First?
When it comes to deciding between which loan to refinance, there are several considerations to take into account. Here are two of the most common situations borrowers find themselves in.
Refinance your mortgage first if credit is a concern
Each time you apply for a new line of credit, such as a refinance loan, the lender will pull your credit to get your score. This is called hard credit inquiry, and it can lower your credit score by about 10 points.
When you apply for the same type of loan within a certain time frame, these multiple hard credit inquiries will count as one. This means you won’t get penalized if you apply for auto refinance loans with several lenders within a week or two to shop for rates.
However, that does not apply if you apply for both auto loan refinancing and mortgage refinancing at the same time. Those are two different types of loans and will count as two separate hard inquiries, both dropping your score a tad as a result. You can try services like Experian Boost to help offset the credit inquiries, but you can also just use that bump in your credit score to get an even better loan offer.
If your credit score is lower than you’d like it to be or at risk for dropping too low to qualify for a competitive loan offer, it may be wise to focus on that mortgage refinance application first.
You can start with pre-qualification which doesn’t impact your credit score. That way you have an idea of what types of loans are available. If you’re still unsure, you can speak with a mortgage loan officer or broker to get more information before doing a hard credit check.
Refinance your car loan first if your debt-to-income ratio is over 43%
You can have great credit but still struggle to get an approval for mortgage loan refinancing if your debt-to-income ratio is over 43%. Since auto loan refinancing has a higher maximum DTI, around 50%, you can refinance your car loan to help you qualify for the mortgage refinance loan.
Here’s how it works: While hard credit inquiries do impact your credit score, the truth is they’re really just a small slice of the credit pie, about 10%. And credit score is only one of many factors that lenders take into consideration when evaluating loan applications. Your debt-to-income ratio is another significant piece of information.
If refinancing your car loan lowers your DTI to meet your mortgage lender’s guidelines, the benefit can outweigh the small credit hit from the car refinance loan application. In other words, refinancing your car loan helps your mortgage refinance application.
Before you submit any refinance application, find out your credit score. You can get scores for free on sites like Credit Karma and Credit Sesame. You may also have access to your free score through your credit card company or other credit service.
Make sure your car loan doesn’t have any prepayment penalties
A penalty for paying off a car loan early? Yes, it’s true. While rare, prepayment penalties can cost a lot of money, possibly too much to even consider refinancing for any financial benefit.
If you have a good credit score, you likely don’t need to worry. You’ll see this more often with buy-here, pay-here loans or subprime auto loans. Check your loan contract or reach out to your current lender to verify.
Does It Really Matter Which Loan I Refinance First?
In the end, personal finance is just that: personal. Not everyone is obsessed with getting the best rate or loan. Improving a financial situation is sometimes enough of a reward.