In most cases, a fixed-rate car loan is the best option. That’s because a variable-rate auto loan carries the risk of increased monthly payments. Variable-rate car loans may have an advantage if you don’t plan on holding the loan for a long period.
If youre thinking about financing a car, youll find loans that come with either fixed or variable interest rates. With fixed-rate auto loans, the interest rate remains the same for the entire loan term, while the interest rate on variable-rate car loans can change periodically.
Generally, a fixed-rate car loan is your best option. Thats because a variable rate auto loan carries the risk of increased monthly payments when interest rates rise. Longer-term variable-rate loans are especially risky because there is more time for the interest rate to rise.
When it comes time to finance a new car purchase, one of the biggest decisions buyers face is whether to get a fixed-rate or variable-rate auto loan. While both have their pros and cons, understanding the key differences is crucial to selecting the best loan for your needs and budget. This comprehensive guide will explain fixed vs. variable car loans, compare the benefits and drawbacks of each, and provide tips for choosing the optimal financing.
What is a Fixed-Rate Auto Loan?
A fixed-rate car loan is one where the interest rate stays the same over the entire life of the loan. Typical terms range from 24 to 84 months, so with a fixed-rate you’ll pay the same rate month-to-month and year-to-year until the loan is paid off.
Lenders determine your fixed interest rate based on current market conditions as well as your credit score income and other risk factors. Those with excellent credit tend to qualify for the lowest fixed rates, while borrowers with poor credit pay higher interest.
The interest rate on a fixed auto loan is expressed as an Annual Percentage Rate (APR) This accounts for the base interest rate plus any fees charged by the lender Shopping around for the lowest APR can help save money over the long run,
Benefits of Fixed-Rate Car Loans
Fixed-rate auto loans offer several advantages for borrowers:
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Predictable payments – Your monthly payment stays the same for the duration of the loan, so it’s easy to budget.
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Interest rate stability – You lock in your rate upfront, so there’s no risk it will increase later. This provides peace of mind.
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Typically lower rates – Fixed rates tend to be lower than variable rates for longer-term loans of 5 years or more.
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Easier qualification – Lenders often prefer fixed-rate loans, so borrowers with lower credit scores may have an easier time qualifying compared to variable.
What is a Variable-Rate Auto Loan?
Unlike fixed-rate loans, variable-rate auto loans have interest rates that can fluctuate throughout the loan term. The rate is tied to an index like the prime rate, so if that index goes up or down, your auto loan APR follows.
For example, if your loan has a rate of prime + 2%, and the prime rate increases from 5% to 6%, your new loan rate becomes 8%. This results in higher monthly payments. Variable loan rates are adjusted periodically, such as monthly, quarterly, or annually.
Benefits of Variable-Rate Car Loans
While they come with some risk, variable auto loans can also provide advantages:
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Lower initial rate – The starting rate may be lower than a comparable fixed loan. However, it can increase over time.
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Potential interest savings – If index rates decrease, your interest rate drops too, lowering monthly payments.
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Flexible terms – You can sometimes pay off a variable loan early with less penalties compared to fixed.
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Rate caps – Many variable loans limit how high the rate can go, protecting against runaway interest rates. Ask lenders about their policies.
Key Differences Between Fixed and Variable Car Loans
When deciding between fixed vs. variable auto financing, weigh these key differences:
| Factor | Fixed-Rate Loan | Variable-Rate Loan |
|---|---|---|
| Interest rate | Stays the same | Can go up or down |
| Monthly payments | Fixed | Can change |
| Long-term costs | More predictable | Can be unpredictable |
| Qualification | Easier | Potentially more difficult |
| Early payoff | May have penalties | Typically more flexibility |
Tips for Choosing the Best Car Loan Type
So how do you decide what’s right for your situation? Here are some tips:
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Check current rates – Compare fixed vs. variable rates now. Variable may be lower to start.
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Consider loan term – Shorter loans have less risk. Fixed rates tend to be better for loans 5 years or longer.
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Think long-term – Weigh predictability vs. potential future savings from a variable rate dipping.
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Understand index rates – Know how underlying rates like prime influence variable loan rates.
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Compare total costs – Run loan calculators to see total interest costs for each option.
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Check early payoff policies – Review flexibility to pay off loans early, and any penalties.
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Assess rate caps – For variable loans, higher caps allow more interest rate risk.
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Check your credit – Those with excellent credit often get the best rates on fixed or variable loans.
Where to Get the Best Auto Loan Rates
Once you decide between fixed vs. variable, it pays to shop around among multiple lenders to compare rates. Here are some of the best places to get auto loan quotes:
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Banks and credit unions – Traditional lenders often offer competitive rates and flexible terms.
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Online lenders – Companies like Lightstream and PenFed provide easy online applications for fixed and variable car loans.
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Manufacturer financing – Options like Ford Credit or Toyota Financial Services may subsidize special rates on new cars.
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Dealership financing – The dealership can arrange financing, but may not offer the lowest rates.
How Credit Impacts Auto Loan Rates
Remember, your credit score plays a major role in determining auto loan interest rates. Borrowers with credit scores of 740 or higher tend to qualify for the lowest rates from lenders. Taking steps to improve your credit can help you save significantly on financing costs:
- Pay all bills on time each month
- Lower credit utilization below 30%
- Pay down existing debts
- Check for errors on your credit reports
- Limit new credit applications
Shopping around with multiple lenders while having excellent credit is the key to getting the best deal on your next auto loan. Be sure to compare both fixed and variable rate options to make the right financing choice for your needs.
Frequently Asked Questions (FAQ)
Q: What is the lowest auto loan rate currently available?
A: The lowest rates currently advertised are around 2-3% APR for borrowers with exceptional credit scores. However, actual rates vary by lender. Shop around for the best deals.
Q: Who typically offers the lowest interest auto loans?
A: Online lenders like Lightstream and credit unions are good sources for low rate auto financing. But shop around, as rates are personalized based on your credit profile.
Q: Is it easier to qualify for a fixed or variable rate car loan?
A: Fixed rate auto loans usually have lower qualification standards compared to variable rate loans. Those with lower credit scores may have better luck with fixed rate financing.
Q: Can I get a variable interest rate on a used car loan?
A: Yes, you can qualify for a variable rate when financing either new or used car purchases. However, interest rates may be higher for used cars, especially from dealerships.
Q: What happens if interest rates rise sharply on a variable loan?
A: Your monthly payments would go up significantly. That’s why variable loans come with more risk. Be sure to assess potential payment increases before committing.
The Bottom Line
Choosing between a fixed or variable interest rate for your auto loan is an important decision. Fixed rates provide predictable payments but variable rates offer the possibility of lower long-term costs. Carefully compare options to select the best loan for your financial situation. Improving your credit score can help you qualify for the lowest rates too.
Pros of Variable-Rate Car Loans
- Flexible rate: A variable-rate car loan may have a lower interest rate at the beginning of your loan term. If you have a loan with a short term, such as two years, or you plan to aggressively pay down a longer-term loan, your loan may be paid off before rates rise significantly.
- Interest rate may be capped: Many variable-rate car loans have an interest rate cap the loan cant exceed. You might consider a variable car loan if this so-called “ceiling rate” isnt too far above the fixed rate a lender offers you.
Pros of Fixed-Rate Auto Loans
- Predictability: A fixed-rate car loan is ideal for longer-term financing because the APR and payment never change over the duration of the loan, regardless of whats happening in the market.
- Long-term benefits: Generally, the longer the loan, the more risk the market interest rate will rise. With a fixed-rate loan, you have the peace of mind that your interest rate will never increase.
- Widely available: Most car loans have fixed interest rates, and you can apply for one through a dealership, bank, credit union or an online lender. Comparing multiple quotes is a wise strategy to find the lowest rates before making your decision.