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.
Buying a new or used car is an exciting experience. However, the financing process can be confusing, especially when it comes to choosing between a fixed or variable interest rate auto loan. I’ll explain the key differences between these two types of car loans and provide tips to help you decide if a fixed or variable rate is better for your situation.
What is a Fixed Rate Auto Loan?
A fixed rate auto loan has an interest rate that remains the same over the entire term of the loan Your monthly payments do not fluctuate – they stay the same from the first payment to the very last one.
Here are some key features of fixed rate car loans
- Interest rate stays constant for the full loan term (usually 3-6 years)
- Monthly payments are predictable and do not change
- May have higher interest rates than variable rate loans initially
- Lower long-term risk since rate never rises
Fixed rate loans provide stability and predictability. You always know exactly what your monthly car payment will be, making it easier to budget. The interest rate you qualify for depends on factors like your credit score, income, and overall debt levels.
Even if market interest rates rise or fall during your loan term, your locked-in fixed rate and monthly payments remain unchanged. This protects you from payment increases if rates trend upward.
What is a Variable Rate Auto Loan?
Unlike fixed rate loans, variable rate auto loans have interest rates that can fluctuate over the loan repayment period. The interest rate is tied to an index rate, usually the prime rate. When the index rate changes, your interest rate adjusts up or down accordingly.
Here are some key features of variable rate car loans:
- Interest rate fluctuates based on underlying index rate
- Monthly payments can go up or down over loan term
- Typically have lower initial interest rates than fixed loans
- Rate and payment caps may apply to limit increases
- Higher long-term risk since rates can rise over time
The biggest risk of variable rate loans is that your monthly payments could increase significantly if interest rates trend upward. However, you could benefit from declining payments if rates decrease.
Lenders often put caps in place to limit rate hikes on variable loans. For example, your rate may not be allowed to rise more than 2% per year or 6% over the full loan repayment term. Pay attention to any rate caps when reviewing variable rate loan offers.
How to Decide: Fixed vs. Variable Car Loan
So should you choose a fixed or variable interest rate for your next auto loan? There are pros and cons to each option. Consider these key factors as you make your decision:
1. Loan Term
The longer your loan term, the higher the risk that rates could rise substantially over the life of a variable rate loan. A variable rate is riskier on a 6-year loan than a 3-year loan. Locking in a fixed rate makes more sense for longer loan terms, unless you’re confident interest rates will decline.
2. Interest Rate Outlook
Think about economic forecasts and whether rates seem likely to rise, fall, or remain steady. If rates appear set to climb, a fixed rate protects you from increases. If the outlook suggests declines, a variable rate could mean lower payments. Of course, no one can predict rate movements with total certainty.
3. Budgeting Priorities
How important is predictable budgeting and knowing your exact monthly car payment? If you want set payments you can rely on, a fixed rate auto loan brings peace of mind. If you have budget flexibility and don’t mind fluctuating payments, a variable rate loan may offer advantages.
4. Ability to Refinance
Consider your ability to refinance down the road if needed. If your variable loan rate and payment spike and you have the credit profile to qualify for refinancing, you can look into a new fixed rate loan to lock in better terms. If it would be difficult to refinance, a fixed rate from the start provides more certainty.
5. Paying Ahead and Payoff Timeframe
Do you plan to make extra principal payments and pay off your loan early? Variable rate loans can provide short-term savings if you pay ahead aggressively. However, keep in mind the longer it takes you to pay off the loan, the greater the risk your rate and payments could rise.
Tips for Finding the Best Car Loan
Follow these tips when searching for your new or used auto loan:
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Check your credit reports and scores. This gives you an idea of what rates you may qualify for based on your credit history. Also correct any errors that could be negatively impacting your scores.
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Research current auto loan interest rates. Compare fixed and variable rate options by checking lender websites and using online loan search tools. Rates vary based on your credit, loan amount, and other factors.
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Get pre-qualified to view potential loan offers before you shop for vehicles. Pre-qualification is a soft inquiry that doesn’t affect your credit scores.
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Compare multiple lender quotes. Don’t just accept the dealership financing offer. Compare quotes from banks, credit unions, and online lenders to find your lowest rate.
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Run the numbers. Calculate total loan costs by plugging in your loan details to determine the best overall deal. Lower rates don’t always mean lower total costs.
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Read loan terms carefully. Pay attention to APRs, loan lengths, down payment requirements, and any fees. Ask questions if you don’t understand key loan terms.
When weighing fixed vs. variable auto loans, think about your own financial situation, interest rate predictions, and budget flexibility. There is no one-size-fits-all answer. Doing your homework gets you the best rate and loan terms to finance your new ride.
Fixed vs. Variable Auto Loan Rates: Examples
To highlight the differences between fixed and variable rate auto loans, let’s look at two examples:
Sarah’s Fixed Rate Loan
- Vehicle Purchase Price: $30,000
- Loan Amount: $25,000
- Loan Term: 5 years (60 months)
- Fixed Interest Rate: 5%
- Monthly Payment: $468
Over the 5-year loan term, Sarah’s monthly payments are always $468. Even if market interest rates rise or fall during those 60 months, Sarah’s fixed monthly payments stay the same until she pays off the loan.
Michael’s Variable Rate Loan
- Vehicle Purchase Price: $30,000
- Loan Amount: $25,000
- Loan Term: 5 years (60 months)
- Starting Variable Interest Rate: 4%
- Starting Monthly Payment: $452
Michael’s initial interest rate is lower than Sarah’s fixed rate loan. However, his 4% variable rate is tied to the Prime Rate. Any changes in the Prime Rate up or down will cause Michael’s interest rate to fluctuate.
For example, if the Prime Rate rises 1% in Year 3 of Michael’s loan, his interest rate will increase to 5% and his monthly payment will jump to $468. If the Prime Rate decreases, his payment would also decrease. Michael’s rate and payment could fluctuate throughout his loan term.
This illustrates the benefit of lower initial rates but unpredictable long-term costs with a variable rate loan. Sarah enjoys predictable payments with her fixed rate loan.
The Bottom Line
Choosing between a fixed and variable rate loan involves weighing predictability against flexibility. Here are a few final tips on making this key auto financing decision:
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For lower long-term risk, a fixed rate is generally preferable, especially on longer-term loans.
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Be conservative with your interest rate forecasts. No one knows exactly what rates will do.
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Caps on payment increases provide some protection with variable loans.
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Weigh your budget priorities and ability to handle fluctuating monthly payments.
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Use online tools to compare loan costs and determine the best overall pricing.
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If choosing a variable loan, pay ahead aggressively to pay off the balance before rates rise substantially.
With some thorough research and number crunching, you can confidently decide whether to lock in a fixed rate or float with a variable rate for your next auto loan. Your personal financial situation and loan details play a big role in determining which option makes the most sense.
Pros and Cons of Variable-Rate Auto Loans
Variable-rate car loans have their advantages and disadvantages as well.
How Do Variable-Rate Car Loans Work?
A variable-rate car loan comes with an interest rate that may periodically change. The interest charged on the loan is tied to an underlying benchmark, usually the lenders prime rate, which can change with market conditions. If a prime rate increase causes your loans interest rate to go up, expect a higher monthly payment amount as a result.
To determine the initial interest rate for your loan, your lender will consider the prime rate, market conditions, your credit score, income and debt levels, and other factors. A variable-rate auto loan may be a good option when you expect the rates to decline during the loans repayment term.
Interest Rates on car loans – (Fixed and variable)
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%.
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.
What happens if interest rates fall on a variable-rate auto loan?
With variable-rate loans, you take the chance that interest rates might rise, which means the rate on your loan would likely go up. Some variable-rate auto loans do come with caps on interest rates, meaning the rates can only go so high, which may be helpful. And if interest rates fall, your auto loan interest rate could go down.
How does a variable rate auto loan work?
That means with a variable-rate auto loan, your rate could go up if the prime rate goes up, which would make your monthly payments higher. Lenders use the prime rate as a base to determine your interest rate for an auto loan, and they also take into consideration such factors as your income and credit score . How Do Variable-Rate Auto Loans Work?
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.
Should you choose a fixed rate or variable rate loan?
You might prefer fixed rates if you are looking for a loan payment that won’t change. With a variable-rate loan, the interest rate on the loan changes as the index rate changes, meaning that it could go up or down. Because your interest rate can go up, your monthly payment can also go up.