Fixed-Rate vs. Variable-Rate Car Loans: What You Need to Know

Choosing between a fixed rate or a variable rate loan when financing a car is one of the most important decisions you will make. There are pros and cons to each option, and understanding how they work can help you find affordable car loan options that fit your budget and financial goals. In this guide, we’ll take a look at the differences between these two interest rate structures and how they could affect your car loan repayment.

What Is a Fixed-Rate Car Loan?

A fixed rate car loan has an interest rate that stays the same throughout the life of the loan. What this means is that your monthly payments will never change from the beginning to the end, which is stable and predictable. Borrowers who like a steady repayment schedule and don’t want to be subject to fluctuating rates often choose fixed rate loans.

Advantages of Fixed-Rate Loans

One of the major benefits of a fixed rate loan is the peace of mind it brings. If you know that your payments won’t change based on market conditions, it makes budgeting easier. A fixed rate can be an excellent choice for those who intend to keep the car for the full term of the loan. Further, fixed rates are often preferable when interest rates are relatively low since they lock in those favorable terms for the life of the loan.

Drawbacks of Fixed-Rate Loans

Fixed rate loans are stable, but have drawbacks. If the interest rates fall after you have obtained your loan, you won’t benefit from the lower interest rates unless you refinance. Also, depending on the state of the market, you may have to pay more in interest over the course of the loan because fixed rate loans may have higher initial rates than variable rate options.

What Is a Variable-Rate Car Loan?

A variable rate car loan has an interest rate that can change over time, based on changes in the market. These loans are generally tied to an index, such as the LIBOR (London Interbank Offered Rate) or prime rate, and your rate will change periodically, usually annually or quarterly. The initial rate may be lower than a fixed rate, but it’s important to consider the possibility of future rate increases.

Benefits of Variable-Rate Loans

The key advantage of a variable rate loan is the possibility of lower initial rates. The lower your interest rates when you take out the loan, the lower your starting payments will be. In addition, if market rates stay the same or decrease over time, your loan payments could even be lower. If you are looking to pay off your loan quickly, a variable rate loan may be attractive as you may be able to take advantage of the lower rates without the long-term fluctuations.

Risks of Variable-Rate Loans

The major downside of a variable rate loan is the uncertainty. If interest rates rise during the term of your loan, you will pay more in monthly payments, which could make it harder to keep up with your repayments. If your financial situation changes or if you’ve taken on a loan with a longer term, this can be particularly challenging. Before choosing this option, it’s important to carefully assess your ability to handle potential rate increases.

Which One Should You Choose?

The decision between a variable rate loan and a fixed rate loan ultimately boils down to your financial circumstances and personal preferences. If you appreciate consistency and predictability in your monthly payments, a fixed rate loan is probably a better option. A variable rate loan might be a wise option, though, if you can live with some degree of uncertainty and would like to benefit from potentially cheaper rates in the near future.

Consider Your Financial Goals

Consider how long you intend to retain the car and whether you anticipate an increase or decrease in interest rates in the near future when choosing between the two. Long-term borrowers who wish to prevent surprises may benefit from fixed-rate loans, but those who intend to pay off the loan fast or refinance if needed may benefit from variable-rate loans.

Final Thoughts

Selecting the right interest rate structure for the loan you are taking out is a crucial step in the financing process. If you know the pros and cons of both fixed rate and variable rate loans, you will be in a better position to make an informed choice. Remember that, no matter what type of loan you are looking at, it is important to research all of the affordable auto loan options so you can find the best one for your specific financial situation.