What Does My Car’s Worth Have to Do With How Much a Lender Loans Me?
Have you ever wondered how banks decide how much to lend you when you apply for an auto loan?
There are many factors banks use to evaluate risk. You are probably familiar with most of them including your credit and credit score, your debt and your income. You may even know that every lender weighs these factors differently.
One factor frequently overlooked (until the last minute) is the asset requiring a loan itself, like a home or car, and more specifically, what that asset is worth.
Understanding a fancy little term called loan to value (LTV or LTV ratio) will help you understand how a lender decides how much to loan you to buy an asset – in this case, a car!
LTV Ratio Definition
Loan to value is a risk factor financial institutions evaluate when determining whether to approve or deny a loan application. The loan is how much the lender plans to lend you, and the value relates to how much the asset in question is worth.
There is a formula banks use to evalute LTV, and that’s up next, but first you need to know…
Another Definition: What is LTV Percentage?
A lender’s LTV percentage determines the amount it will typically lend for an auto loan. Some banks will loan up to 100 percent of the car’s value – maybe more – and others lend slightly less, requiring a downpayment on the vehicle in most cases.
Risky Business: What’s the Big Deal?
From a financial institution’s propective, a loan is an investment in your asset. The likelihood of a bank or other lender losing money on its investment increases when the value of the asset decreases.
If Sally buys a car, for example, with a loan amout of $25,000, and she defaults on that loan, her bank’s only recourse is to repossess her car. But if the market value (more on that later) is only worth $22,000, less than the outstanding loan balance, there is no way the lender can recover the $3000 difference. (Ouch! Sally was a bad investment.)
For this reason, high loan to value ratios are usually considered high risk for financial institutions.
If The Lender Will Loan You 100% +
- Lender A finances deals with LTVs of 110 percent, and
- Lender B finances deals with LTVs of 130 percent.
If you simply want to finance the cost of your purchase, which happens to be $20,000, then in this situation, both lenders could lend to you because your loan will have an LTV of about 100 percent.
If The Bank Lends You Less Than You Need
- you have $4000 negative equity in your vehcile and want to refinance, or
- you have a $4000 debt from a previous car loan that needs to be rolled into the new loan?
In either case, you need to borrow a total of $24,000 from the lender, which means you need an LTV of at least 120 percent – the true market value of the car is less than the value of the loan.
Now, only Lender B would be able to make you a loan offer, or you will have to put down a down payment to cover the $4000 difference.
Steps To Determine a Bank’s LTV %
Contact the financial institution you hope to use to determine what its LTV percentage is. For this, you may also need to know:
- What resource the bank uses to determine vehicle value – the NADA, Black Book or Kelley Blue Book values may all be different from one another.
- Whether the lender uses vehicle’s trade in, loan, or retail value to calculate it’s LTV.
- If the lender includes tax, title and license in it’s calculation. This may impact what you may have to pay out-of-pocket.
After you’ve gathered this info, look up the value of your vehicle using the same source the lender uses to determine the appropriate value, again using the same value as the lender. Then do some math!
Vehicle Value * LTV% = Vehicle Loan Amount
For example, let’s say you want to buy a car worth $25,000. If the lender you hope to get a loan through has an LTV of 120 percent, then your maximal loan amount with this lender is $30,000 for your car.
Full Circle: The Other Asset Factors
Don’t forget the LTV ratio is not the only criteria used to evaluate the risk (or not) of loaning you money for your car. Vehicle age and mileage are also important.
And then there is your credit history, debt, income and debt to income ratio…
Take the guess work out of car loan shopping. Let IFS search for an auto loan that meets your needs. We specialize in auto loan refinancing, leased vehicle purchases, company car purchases, and more.
Is auto refinancing right for you?
Refinancing may help you…
- Lower your monthly payments
- Decrease your interest rate
- Remove someone from your loan
When you apply to refinance through Innovative Funding Services (IFS), your dedicated Finance Advisor will search for a car loan that meets your needs from our network of 25+ national lenders. We offer up to 100% financing for applicants with credit scores of 525-850 and with a range of LTVs.