NAFA member, Adam Meredith, President of AOPA Aviation Finance Company, explains the credit matrix when looking for an aircraft loan.
An AOPA Finance client recently requested a quote for financing a single-engine aircraft. He was looking to finance $70,000, and was quoted what the interest rate would be based on that figure. However, had the client borrowed $75,000 instead of $70,000, the rate would have been a whole percentage point lower, saving him money. Why is that?
Many borrowers believe the way to get the best interest rate is through a large down payment and a great credit score. But actually the No. 1 factor in determining the interest rate offered on a loan is the amount of money being lent. Lenders structure each loan around a credit matrix. The matrix is comprised--among other things--of ranges of loan amounts, the loan-to-value (LTV) ratio, an individual's total financial picture, and least of all, that person's credit score.
Lenders group loans into "buckets," or ranges of loan amounts. For example, in the case of our client, one range included loan amounts from $50,000 to $74,999. Additionally, each range of loans has a default initial interest rate associated with it.
In this case, the lender's next higher range had an interest rate one full percentage point lower associated with it. This client had said a top priority of his was to get the lowest possible interest rate. Therefore, we knew if our client had the flexibility to increase his loan by $5,000, it would put him in the higher range, where the default lending rate was better.
Initially, he saw increasing the loan by $5,000 as beneficial only for the lender. We pointed out that this lender also had a loan structure that allowed for additional prepayments without penalty. If our client was willing to hold back $5,000 of his down payment and increase the loan to $75,000, he could, on Day 2 of the loan, take that held back $5,000 and apply it immediately to the principal. That would get him back to $70,000 on the loan while maintaining the lower interest rate of the $75,000 loan, thus saving him money. That’s one example of how borrowing more can cost less.
Loan-to-value (LTV) is the second-most important element in constructing the credit matrix. LTV is a financial term used by lenders to express the ratio of a loan to the value of the asset purchased. Generally, an LTV of 80%-85% is deemed an acceptable risk. LTV requirements are most frequently influenced by the aircraft and how quickly it is likely to depreciate. In other words, LTV requirements may be applied on a sliding scale. Generally, the more quickly a plane is likely to depreciate, the more money down or lower an acceptable LTV and vice versa. Additionally, by putting even more money down and thus lowering the LTV you can frequently gain better interest rates and terms.
The last, and least important, component of the credit matrix is one's credit score. Despite what retail financial institutions and credit reporting agencies pushing credit protection products advertise in the media, credit scores for aircraft loans have only a small influence on how lenders determine a loan's interest rate. The difference between a good credit score and a great credit score might be a mere quarter of a percent. It’s a lousy credit score that will hurt the most. A poor credit score may cost the borrower a full percentage point, or the loan itself.
Ultimately, obtaining the best loan for you is about providing you the best perspective on all aspects of it. AOPA Finance brokers stand ready to share the kind of knowledge, nuance and expertise that can navigate you to the best loan for your situation.
This article was originally published by AOPA Aviation Finance Company on May 28, 2019.