Editor’s Note: This article was originally published on February 8, 2014. It has been updated on January 22, 2020, to reflect up-to-date lender practices and edited for clarity.
With interest rates at low levels, I decided to see if I could lower the interest rate on my existing auto loan.
When it comes to any credit application, my student loans are the big hurdle. Like millions of Americans, whenever I apply for credit, any prospective lender does a double-take when they see how much student loan debt I have.
Despite my concerns, I was able to find a lower interest rate on my car loan. The key was to find a lender who understood how to handle my income-driven repayment plan.
Most banks and creditors have no idea how to handle large amounts of student debt
I got an extremely wide range of responses when I submitted my refinance applications.
Some lenders offered me interest rates as low as 3%, while others couldn’t even offer me a loan. I suspect this is as a direct result of my student debt. My credit score and salary both could be described as decent but not great. Outside of student debt, my credit profile is pretty solid.
When lenders are deciding on whether or not to offer you a loan, they are trying to decide whether or not it is something they think you can afford. They will look at your monthly income and compare it to your current expenses according to your credit report. The industry term is the debt-to-income ratio.
The wildcard in my debt-to-income ratio was my student loans. More specifically, many lenders were confused at how to deal with my Income-Driven Repayment plan payments. One lender specifically called me to discuss my student loans. He figured that I was on a deferment and expected my monthly obligation to go up dramatically. I had to explain IBR and how it worked.
When lenders pull an individual’s credit report, there is no way to determine what student loan repayment plan they are one or when the terms will be changing. Because of this, the lenders don’t know how to process this information. Some will give you the benefit of the doubt and offer a loan based upon your reported required monthly payment. Others will assume it will go up and deny your loan entirely. Finally, some will call and ask for more information.
Dealing with an Automated Process
Unlike home loans, for most new or used car loans, credit approval is an automated process (this is why many can provide instant approval online). From my auto refinancing experience, it appears that these automated processes vary greatly from one institution to the next.
Over the years, most lenders have gotten better about handling student loans and income-driven repayment plans. Most will now accept small monthly payments, even if there is a large student loan balance.
The one issue that might trip up many of the computers making the approval or rejection decisions would be borrowers who have a $0 per month payment. Computers may view this as a deferment and assume a monthly payment of 1% of the loan balance. For borrowers with larger loan balances, this can easily cause a rejection.
The good news is that many lenders can reconsider applications. If you get rejected from a lender with a good reputation and low rates, it might be worth your time to give them a call and explain that the $0 per month payments are legitimate. They may be able to tweak the numbers in their system so that you can get approved.
Cast a wide net – There is only upside
There are a ton of places offering car loans. Use this to your advantage. Because you don’t know how most banks and credit unions will handle your student loans, shopping around is essential to get the best deal.
If you are worried about many credit inquiries hurting your credit score, don’t be. As long as they are within a 45-day window, the credit scoring matrix will identify this as rate shopping and will treat all of the inquiries as one.
I was very surprised with the results that I got on my applications. Lenders I thought would offer an excellent rate denied me completely, while lenders I had little faith in made great offers.
The other advantage of shopping around is that you force the banks to compete for your business. They may have some rate flexibility, and you might be able to use one offer to get an even lower rate elsewhere.
Final Thought – Anything is possible
Student loan debt is growing at a tremendous rate and has finally gotten national attention. Unfortunately, many financial institutions are still struggling to figure out how to handle it.
Because there is no “industry standard” for dealing with applicants with student loans, you will see a variety of responses. If you keep this dynamic in mind and shop around, a reasonable rate can still be had.