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When you’re financing a car, you can choose either a fixed-rate or a variable-rate loan. With fixed-rate loans, the interest rate remains the same over the life of the loan. Adjustable-rate car loans, on the other hand, have an interest rate that may change. For many borrowers, it may be better to go with a fixed-rate car loan. An interest rate that remains the same is easier to budget for. Plus, you avoid the risk that the rate could rise, causing your loan to become more expensive. However, there are situations in which an adjustable-rate car loan can make sense.Here’s what you need to know to help make the choice between a fixed vs. variable interest rate on a car loan.
Are Car Loans Fixed or Variable?
Most car loans are fixed-rate loans, meaning your rate and monthly payment remain the same over the life of the loan. Variable- or adjustable-rate car loans are less common but do exist, typically tied to an index like the prime rate — causing your payments to rise or fall with market changes.
How Do Fixed-Rate Car Loans Work?
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 6.84% for new cars and 12.01% for used cars. The rate you pay may be lower or higher, depending on your credit score. Lenders largely calculate interest rates on your credit history. A high credit score indicates to a lender that you’ve responsibly managed and paid back debts. As a result, they may give you a lower interest rate. Borrowers with poor credit scores are considered more of a risk. Lenders compensate for that risk by offering higher interest rates. The interest rate on a car loan is often listed as an annual percentage rate (APR), which also includes loan fees. Because the fees are included, an APR on a car loan tends to be slightly higher than the interest rate, but it’s a more accurate representation of what a loan will cost you. Recommended: 0% APR Car Loan: How Can You Get One?
Benefits of Fixed-Rate Loans
Advantages of fixed-rate loans include:
Availability: Fixed-rate loans are easy to come by and can be found through car dealerships, banks, credit unions, and online lenders. The more loan options you have to choose from, the better the chance that you’ll find one with a lower interest rate and favorable loan terms.
Stability: With a fixed interest rate, you know exactly how much you’ll pay over the life of a loan. Fixed-rate loans may be ideal for car loans with long terms, since the longer the term of a loan, the greater the risk that interest rates might rise.
Cons of Fixed-Rate Loans
There are also drawbacks to fixed-rate loans, such as:
Opportunity cost: A fixed-rate loan doesn’t allow you to take advantage of falling interest rates. However, if rates drop, you could explore the idea of car loan refinancing, which might help you get a lower interest rate on a new loan.
The fixed rate might be higher: A lender might charge a higher interest rate for a fixed-rate loan.
Interest rates on variable loans can fluctuate. They’re often pegged to the lender’s prime rate, which is the rate lenders use to set interest rates for loans. If the prime rate changes, the interest rate on a variable loan may change as well. What could cause the prime rate to change? Banks often use the federal funds rate to help set their prime rate. The Federal Reserve may raise or lower the federal funds rate in an effort to influence the economy. For example, the Fed might raise interest rates to help combat inflation, or lower interest rates to stimulate the economy.
Benefits of Variable-Rate Car Loans
These loans have some pros to consider, including:
Potentially lower rates: If the interest rates are lower when you take out a variable-rate loan, they might stay that way for a while. Repay your loan within that period, and you may never have to pay higher rates. And if interest rates fall, once your variable-rate loan readjusts, you may get a lower interest rate.
Capped rates: Some variable-rate loans have an interest rate cap. That means your interest rate can’t continue to rise without limit. If this cap is similar to the rate you’d get with a fixed-rate loan, a variable rate may be worth considering.
Cons of Variable-Rate Car Loans
Variable-rate loans also have disadvantages, such as:
Volatility: Interest rates are usually based on a lender’s prime rate. If that rate rises, you may end up paying more on your loan. Changing rates can be hard to plan for in your budget.
Initial rates may be fleeting: A lender may offer low introductory rates on a variable-rate loan to entice you, but those rates might not last for long. Once the introductory period is over, your interest rate may make a big jump up.
In addition to weighing the pros and cons outlined above for fixed vs. variable interest rate loans, you should also consider the following factors when choosing a car loan.
Loan Term
The longer the term of your loan, the greater the chance there is that interest rates could rise. A fixed-rate loan may be a better option for a loan with a longer repayment period.
Risk Tolerance
If you appreciate predictability and have a low tolerance for risk, a fixed-rate loan might be right for you. However, if you believe interest rates may fall, and you can live with the possible risk that they could rise, a variable-rate loan may be your choice. Just be sure to include some room in your budget in case rates go up.
Interest Rates
If you expect interest rates to climb in the near future, you’ll likely want to avoid a variable-rate auto loan and opt for a fixed-rate loan instead. However, if you think interest rates will soon fall, a variable-rate loan could save you money.
The Takeaway
The choice between a fixed vs. variable interest rate auto loan is a personal one. Consider the benefits and drawbacks of each type of loan, along with your risk tolerance, to help decide which loan option is best for you.The good news is that you typically don’t have to stick with the same car loan, especially if it’s costing you money. If you think you might qualify for a loan with a lower interest rate or you need to lower your monthly payment, you might consider refinancing your loan.With car loan refinancing, you replace your old loan with a new loan that ideally has a lower interest rate or a different loan term that’s more favorable. If you’re interested in refinancing, Lantern by SoFi can help you compare rates and terms from multiple lenders to help you find the loan that best suits your needs.Find and compare auto loan refinancing rates with Lantern.
Frequently Asked Questions
What’s the difference between fixed and variable rate loans?
How do I know if my loan is fixed or variable?
Are car loans fixed or variable rate?
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About the Author
Austin Kilham
Austin Kilham is a writer and journalist based in Los Angeles. He focuses on personal finance, retirement, business, and health care with an eye toward helping others understand complex topics.
