I will explain my entire thought process behind the decision to refinance my cars. I will start by telling you the reasons why I refinanced and everything that was going on in my mind while I was talking to the credit union for an hour.
I bought both the cars (a Mercedes and a Ford) in 2013. I financed both of them with the manufacturer’s preferred financial institutions because both of them gave me an incentive via a discount on the purchase price.
I had very limited credit history (just one credit card and nothing else, that too was just about 2 years old). The rates that I received were upwards of 9% for one car and upwards of 6% on the other.
Soon afterwards, I refinanced both the car loans with my local credit union. With the exact same credit history (limited), I was able to get an interest rate of 3.89%. They dropped it a quarter point further (0.25% or 25 basis points) because I agreed to take a credit card (this was my second credit card ever).
I made all the payments on time for these 2.5 years. As expected my credit score improved tremendously.
Why did I decide to refinance today
- Interest rate of 3.64% was too high. I knew I will get the best rate (or very close) available given my very good credit history now.
- I wanted cash out of my ‘equity in the car’ – more on that later in this post
- I do not foresee any large purchase on credit coming up soon (like a mortgage), so a little temporary drop in the credit score (by an additional inquiry today) does not bother me.
Here is how the process went
I was on the phone with the credit union. I explained to them my situation and inquired about my refinancing options. The lady on the other side (we will call her Fiona) explained to me the options. She tried to tell me what my monthly payment will be if I refinance it for 24 months.
I was like – why would I want to refinance for 24 months? She was correct in her logic, my original loan term was 5 years, a little over 2.5 years have passed, so she was guessing I will refinance to be in line with ‘getting done with my loans by the 5 year mark’.
I explained to her that I would prefer the loan term again to be 60 months. She told me I will end up paying more interest. I told her I am good with that.
While we were filling the application, I happened to ask her ‘What is the longest term the credit union?’, she said ’75 months’. I immediately said “Oh, then I would like to refinance for 75 months”.
She asked me some details about the cars (most notable was the mileage) that I gladly provided. Given the make, model, year, mileage, packages installed; she came up with a ‘current market value’ of the car. The first car was valued at $26,400 and the second car was valued at 20,xxx (I was too busy running my Excel spreadsheet with other loan related calculations to note down the exact number).
She asked me how much money do I want to get out of my ‘equity in the car’, I said ‘maximum possible’. She said they usually do 80% LTV (Loan To Value). They can go up to 100% but then they suggest that I sign up for gap insurance. She explained to me what gap insurance is and also gave a personal example from her life. I politely declined the gap insurance.
Both my loan applications were instantly approved and she came back with two options – 75 months @2.94% or 60 months @1.94%. Oh, now suddenly I had a choice to make. This is where I struggled the most today, almost everything else was a no brainer.
I decided to go with 60 months @1.94%
- At 1.94%, I feel confident that I will be able to earn a better return on my investments. At 2.94%, I am still confident but not as much – I am not sure if I will invest all the ‘cash out’ in equities, perhaps a mix of equities and fixed income securities (bonds). My personal bonds favorite ETF is BIV. The yield for the last 12 months has been 2.66%.
- There is a strong likelihood that I will not even have these cars for 75 more months. I intend to use them for as long as possible provided I am not hassled by the maintenance and repairs. The cars will be about 9 years old in 75 months, my guess is maintenance problems would trigger an upgrade sooner.
Fiona told me my credit score was 753, I did not inquire about which credit bureau was she referring to. Just to give you an idea about the credit score and FICO score, I knew my FICO score 778.
Oh and one more thing – Although the Mercedes was valued at $26,400; their credit underwriter only approved me of $26,000. I could have requested Fiona to go back to the credit underwriter to change that but I did a quick calculation in my mind – an extra $400 invested per year will give me 8% pre-tax, 6% post-tax, and let’s say I pay credit union 2%, I will have 4% remaining with me. That means $400 * 4% = $16 per year. I did not feel like bothering Fiona for that much money.
And probably I lost an opportunity to a few dollars on the Ford deal too but I can live with that.
The entire process took about an hour, partly because Fiona and I had a couple of friendly conversations in between.
Here is the difference
At 10am: I was paying $836 per month (together for Mercedes and the Ford)
At 11am: I was paying $812 per month and had $22,810 cash in my hand (figuratively – actually I will have the money tomorrow morning)
In case you are thinking my interest rate fell from 3.64% to 1.94% but my monthly payments only fell from $836 to $812. Well, you have to understand that earlier I was paying interest on a certain amount of outstanding balance, now I am paying interest on that certain amount + this additional $22,810.
If you are thinking the other way round – what an awesome deal, I got $22,810 in cash in return of only a $24 increase in monthly payment. Wait – earlier my loan payments would have ended in 2018 but now they will go on till 2020.
- Fiona was also kind enough to overnight the cashier’s check to me that I will receive tomorrow morning (the credit union paid $35 for doing me this favor)
- She also mentioned that a credit score of 730+ is considered A+ by them, so the interest rates would remain unchanged as long as you have more than 730 (mine was 753)
One last tip – if you are trying to take cash out of equity (be it car or any other asset), then the most respectable reason is ‘home improvement’ – a tip that Fiona gave me, probably because she is always friendly or probably because I was very respectful to her, we will never know 🙂
I wrote this entire post because I wanted you (the reader) to know how I think. I wanted you to know how I think so that you can also start thinking like me, thinking like a Pro. And I assure you that you will, if you keep reading my posts.
Disclaimer: Taking cash out of an asset like car or a house is risky, specially if you are not 100% financially responsible. I can very well imagine a case where someone takes out cash out of a car and spends on a vacation -> ending up in more debt rather than building wealth.
Leave a comment with any questions, or suggestions, or agreements, or disagreements. Any discussion is good discussion.