Next to a home, your car may probably be one of the most expensive purchases youll make in your lifetime. And if youre like most people, youll change vehicles a few times in your lifetime. But lets face it, most of us dont have the money to pay for a car or truck outright, which is why we rely on financing to purchase them. Some people may take advantage of financing deals from the automaker while others go to outside lenders. Whichever option you choose, you will have to pay interest on the loan.
But before you sign anything, its important to know how interest rates work on these loans. Getting an auto loan for a longer term with lower interest rates may keep the monthly bill below a budget-busting level, but is it a good deal for you? To answer that question, you need to understand how interest rates on car loans work.
Buying a new or used car is an exciting experience. But for most people affording that shiny new ride requires financing. When it comes to auto loans, you typically have two interest rate options – fixed or variable. But what’s the difference and how do you know which is right for you? Keep reading to learn the ins and outs of fixed vs. variable rate auto loans.
What is a Fixed Rate Auto Loan?
With a fixed rate auto loan, the interest rate stays the same throughout the life of the loan. It doesn’t change with fluctuations in the market or economy.
Here are some key things to know about fixed rate car loans:
- The interest rate is set when you take out the loan and remains constant.
- Your monthly payment amount stays the same.
- You’ll pay the same total interest over the loan term.
Fixed rate loans provide stability and predictability. You know exactly what your monthly car payment will be, which makes budgeting easier.
The loan term for a fixed rate auto loan is usually 3-6 years. Longer terms of 6-7 years are also available, but come with higher interest rates.
Fixed rate car loans are very common. Most lenders offer them, including banks, credit unions, and online lenders.
The interest rate on a fixed rate auto loan depends on
- Your credit score and history
- Your debt-to-income ratio
- Loan amount
- Loan term
- Competition between lenders
In general, borrowers with good credit get the best fixed interest rates on car loans.
What is a Variable Rate Auto Loan?
A variable rate auto loan has an interest rate that fluctuates over the life of the loan. The rate is tied to an index, usually the prime rate. When the index goes up or down, so does your interest rate.
Here’s what to know about variable rate car loans:
- Interest rate changes periodically, based on the index
- Monthly payments can go up or down
- Total interest paid may be higher or lower than estimated
The main index that variable rate auto loans are pegged to is the prime rate. This is the rate banks charge their most creditworthy customers. When the prime rate rises, your auto loan APR will also increase.
Variable rate car loans often start with a low teaser rate. But after a set period, the interest rate becomes variable and could increase significantly. Make sure you understand how high your rate could potentially go.
Pros and cons of variable rate auto loans:
Pros
- Lower initial interest rate
- Rate may decrease and save you money
- Interest rate caps limit maximum rate
Cons
- Monthly payment may increase
- Hard to budget with fluctuating payment
- Total interest costs may exceed fixed rate loan
Variable rate terms are often shorter, from 2-5 years. This reduces your risk of rate spikes over the long run.
Comparing Fixed and Variable Rate Auto Loans
So which type of auto loan is better, fixed or variable rate? There are pros and cons to each option. The right choice depends on your financial situation.
Here’s a quick comparison:
| | Fixed Rate Loan | Variable Rate Loan
|-|
Five-Year Loan at 6% Interest
The interest rate that you get on the loan has a dramatic impact on these numbers. Consider how the numbers change if you had to pay a 6% rate instead of 4% for the same car. Here are the financial details again:
- Original Car Price: $45,031
- Down Payment of 10%: $4,503
- Amount Financed After Down Payment: $40,528
If, after making a 10% down payment upfront, the balance of $40,528 is financed for five years at 6%, the monthly payment would be $783.52. The total paid would be $47,011.19 in monthly payments, including interest of $6,483.19. If we include the initial down payment of $4,503, the total cost of the car would be $51,514.19.
Example of How Car Loan Interest Rates Work
The examples below show how the real cost of a car is determined by the car loan you choose. In every case, the car, the down payment, and the amount to be financed are the same:
- Original Car Price: $45,031
- Down Payment of 10%: $4,503
- Amount Financed After Down Payment: $40,528
How I get THE BEST Current Auto Loan Rates in 2024
FAQ
What type of rate is an auto loan?
Is car loan a fixed or variable cost?
How do I know if my loan is fixed or variable?
Which loans are variable rate?
Is a fixed rate car loan better than a variable rate?
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. That’s because a variable rate auto loan carries the risk of increased monthly payments when interest rates rise.
Are car loans fixed or variable?
Now that you know the answer to the question, are car loans fixed or variable, it’s important to understand how each of these loans works. Fixed-rate auto loans typically have a loan term between 36 and 84 months. During that period, the interest rate on the loan remains the same. The average auto loan interest rate is about 6.07%.
What is a fixed rate auto loan?
Fixed-rate auto loans typically have a loan term between 36 and 84 months. During that period, the interest rate on the loan remains the same. The average auto loan interest rate is about 6.07%. But the rate you pay may be lower or higher, depending on your credit score. Lenders largely calculate interest rates on your credit history.
What is the difference between fixed rate and variable rate financing?
Fixed-rate financing means the interest rate on your loan does not change over the life of your loan. Variable-rate financing is where the interest rate on your loan can change, based on the prime rate or another rate called an “index.” With a fixed rate, you can see your payment for each month and the total you will pay over the life of a loan.