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Guide to Variable vs. Fixed-Rate Auto Loans

Variable-Rate vs Fixed-Rate Auto Loans
Austin Kilham
Austin KilhamUpdated April 11, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
If you’re in the market for a new car, you’ve probably wondered, are auto loans variable or fixed rate? In fact, both types are available, and as a buyer, you’ll need to choose between them. If you opt for a fixed-rate loan, your interest rate won’t change over the life of the loan. Choose a variable-rate loan, however, and the interest rate may go up.For that reason, fixed-rate loans may be the preferable option for many buyers. But there are instances when a variable-rate loan could be beneficial. Read on to learn more about variable vs. fixed-rate auto loans to decide which is best for you.

What Is a Variable Rate? 

The interest rate on variable-rate loans is usually connected to the prime rate, which is the rate used by banks to lend money. The prime rate can go up or down periodically. When the prime rate changes, the variable interest rate usually changes as well. 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?

As interest rates rise, variable-rate loans may adjust their interest rate upwards. As interest rates fall, rates are adjusted down. Generally, variable-rate loans may be beneficial if you expect interest rates to fall, which could help lower your car loan payments. However, rising rates may make your loan more expensive. 

What Is a Fixed Rate?

The interest on fixed-rate loans doesn't rise or fall. The interest rate is set from the beginning, and changes in the prime rate won’t affect it. Fixed-rate loans are easy to budget for, since you know what your monthly payments will be for the length of the loan. A fixed-rate may be better for a loan with longer terms, since the more time involved, the greater the chance interest rates could rise. 

How Do Fixed-Rate Auto Loans Work?

Lenders set fixed interest rates using a method known as risk-based pricing. They look at the borrower’s credit score, income, and the amount of debt they have to calculate what interest rate to offer. In general, borrowers with good credit scores are considered less of a risk, and they tend to be offered lower interest rates. Borrowers with poor credit are seen as being at greater risk of defaulting on a loan. To help compensate, lenders will usually give them higher interest rates. 

Are Auto Loans Usually Fixed or Variable-Rate?

How interest works on a car is that most auto loans have fixed interest rates. You can apply for these loans through car dealerships, banks, credit unions, and online lenders. 

Is a Variable-Rate or Fixed-Rate Better? 

A fixed-rate loan may generally be a better bet than a variable-rate loan. That’s because you avoid the risk that interest rates will rise, especially over the long term. However, every borrower’s financial situation is different, and there are certain situations in which a variable-rate loan could be an option. For instance, if you plan to pay off the loan quickly, and you can get a variable-rate loan that starts with a low interest rate, it might be worth considering.Recommended: Is Car Loan Interest Tax Deductible?

Pros and Cons of Variable vs Fixed-Rate Auto Loans

It’s wise to carefully weigh the advantages and disadvantages of fixed-rate and variable-rate auto loans before making a choice between the two. Fixed-rate loans are predictable. Borrowers don’t have to worry that their monthly payments will go higher if interest rates rise. However, these loans could end up being more expensive. For one thing, fixed-rate loans tend to have a higher interest rate from the start than variable-rate loans do. In addition, it’s possible that interest rates will fall. If they do, fixed-rate borrowers can’t take advantage of them, unless they choose to refinance their loan.
Pros of Fixed-Rate LoansCons of Fixed-Rate Loans
Widely available since most car loans have fixed ratesMay have a higher interest rate at the start than variable-rate loans do. 
Predictable and easy to budget for. Interest rates don’t rise based on the prime rate.Borrowers can’t take advantage of falling interest rates. 
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. Variable loans sometimes offer low introductory interest rates to help entice borrowers. Rates can quickly spike from these introductory levels, however.
Pros of Variable-Rate LoansCons of Variable-Rate Loans
Borrowers can take advantage of falling interest rates. Cost of borrowing can increase as interest rates rise.
May offer low introductory rates, which could be especially useful to borrowers who plan to pay off their loan quickly.Low introductory rates may quickly jump, making variable loans more expensive than fixed-rate options.

Finding the Right Auto Loan Rate Type

When choosing a variable-rate vs. fixed-rate auto loan, consider your risk tolerance. Can you afford to take the chance that interest rates will rise in the future? If not, a fixed-rate loan may be best for you. Think about how long you plan to have the loan. If you’re taking out a short-term auto loan, and you can get a variable-rate loan that starts out at a low rate, you may be able to pay it off before rates rise too much. Also, stay on top of interest rate movements and the auto loan interest rate. A period of rising interest rates is probably not the best time to choose a variable-rate loan. If  interest rates show signs of rising, it may be wise to lock in a fixed rate.Finally, remember that choosing an auto loan type doesn’t mean you have to stick with it. If you want to take advantage of falling interest rates, or you need to make your loan payment more manageable, you have the option of auto loan refinance. When you refinance an auto loan, you pay off your old loan with a new loan that ideally has a lower interest rate or more manageable terms. If your credit score qualifies you for a lower interest rate, your monthly payments may be less. You can also lower your payments by choosing a loan with a longer term, but that will cost you more in interest over the life of the loan. Consider the pros and cons of refinancing a car when interest rates drop or your credit score improves. 

The Takeaway

When it comes to variable rate vs. fixed rate auto loans, borrowers may opt to  choose fixed-rate auto loans, since the interest rate will remain the same over the life of the loan. However, those who plan to pay off their car loan quickly might find that a variable-rate loan works best for them. Either way, you may be able to refinance an auto loan to make it more manageable or lower your payments. If you’re considering auto loan refinancing, Lantern can help you do some comparison shopping. Simply fill out one quick form, and you’ll get offers from multiple lenders in our network, making it easy to compare rates and terms.

Frequently Asked Questions

Is a fixed-rate or variable-rate car loan better?
Can I change from a variable to a fixed-rate car loan?
Will variable rates go higher than fixed rates?
Photo credit: iStock/Dilok Klaisataporn
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About the Author

Austin Kilham

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.
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