When Jay and I were newly dating and neither of us had any cash, nor any credit, but we were in need of a second car… we were at a crossroads.
We agreed that we did not want to buy a barely running car at a high interest rate. Don’t get me wrong, when you’re in a bind–sometimes you’ve got to take the best option available to you…but for us, we did not want to take on some expensive car debt on a questionable car at the very beginning of our relationship.
Yet, we kept getting denied for auto loans. If I wanted to stop spinning my wheels… I HAD to learn what we were up against and play by their rules. Point blank period.
It was at this point that I decided to learn the basics of lending. Ironically, this decision launched my decade long career in finance, but back in 2012…my goal was to learn, and I learned by finding a chart similar to this one. What I learned is that lending is that it all comes down to 1 simple thing… “Risk”.
Think of it this way. If a friend borrowed $100 from you and never paid you back…would you trust them to let them borrow another $50? Would you tell your mom it’s okay to lend them $50? OR would you tell everyone how they stiffed you? Same concept.
I learned that we were trying to get a “secured” loan (versus an unsecured loan), and the trick I used to eventually buy our needed car was learning what “Loan To Value” is.
Jay had no credit, and I had spotty credit. We were not getting approved for $0 down auto loans because we hadn’t demonstrated that we could reliably make our payments on anything. The loans we WERE getting approved for had high interest rates because they wanted to earn as much as they could up front just in case we eventually stopped paying. Basically, we had to get some skin in the game.
Let’s talk about “Risk” again. If you are buying a car worth $10,000 and the lender asks for a $2,000 down payment–the lender is reducing their risk by 20%. Meaning, if you never make your first payment, they could likely sell the car at auction and at least break even. There in-lies the root of every denial we were getting… we looked like a bad risk.
Since I didn’t have cash for a down payment, I had to find another way to get my loan to value dropped. We shopped around hard and eventually found a car being sold at 44% loan to value. It wasn’t what we wanted, but it was a running car with ideal lending math.
The bank approved it…and we made our payments on time. Next time around, the bank saw that we can reliably make payments–so they were more lenient on other loans such as a credit card, a nicer car, and eventually…buying a house.
If the old way isn’t working, it’s on you to do what you’ve got to do.