How Variable Rates Work
A variable rate loan has an interest rate that changes over time, in response to market changes - specifically the US prime rate.
This rate which is typically 3% above the federal funds rate, is a national indicator which shows borrowers with good credit what their ideal rate should be.
Auto loans are typically offered at a fixed rate, although specialist lenders and banks often offer a variable rate alternative.
Variable rate loans can be more risky than fixed term loans, especially if the repayment terms are longer.
Fluctuating interest rates often lead borrowers to go upside-down on their loans or pay a lot more than what they initially borrowed.
The advantage of such a loan is that you will enjoy lower monthly payments for the first year or so of car payments, which in turn can lead to more savings overall.
How Fixed Rates Work
Fixed interest rate loans are loans in which the interest rate remains constant for the entire term, irrespective of the fluctuations in US prime rate.
This results in your payments being the same over the life of the loan. Fixed rates are better for long-term car loans, especially if the interest rates are expected to rise.
A fixed rate loan provides predictability and stability as you will have clarity when it comes to the amounts of the monthly payments over the life of the loan.
This can help you to plan your budget better so you do not miss payments.
The length of the loan term, your credit score, income, and DTI-ratio all play an important part in deciding the fixed rate of interest that will be offered to you.
In any case, to get the best deal, you will have to compare multiple quotes from different lenders such as banks, credit unions, and dealerships.
The Advantages Of Each Type
- Consistent Monthly Payments - With a fixed rate on your car loan, it will not change for any reason over the entire duration of the loan. You will be able to know what your payment is going to be every month, without any fluctuations
- Long-Term Benefits - If you choose a car loan with an extended repayment term, say 72 months or more, you will be able to save money, especially if the rates that you agreed on initially were lower than the current market rate
- Multiple Options to Choose From - There are a variety of banks, credit unions, and online lenders that offer fixed rate loans. You can compare as many quotes as you like to figure out the lowest rates before you make a final decision
Variable Rate Loans
- Flexible Rates - The variable rates depend on either the index or the prime rate. At the beginning of the term, you will probably get low monthly payments. The overall interest that you will pay depends on the market rates, and constantly fluctuates
- Short-Term Benefits - Experts claim that variable rates typically result in borrowers paying less interest than borrowers with fixed-rate loans. The shorter the loan term, the lower the total interest you will pay over the term
When Is The Best Time To Choose Each Type?
The best time to choose a fixed rate loan is when the interest rate is expected to increase.
You can keep an eye out for the changes and fluctuations, and choose the rate when it is at the lowest. This way you will be able to pay the same interest over the entire term.
If you have a good credit score and meet other requirements, it could be another good reason to cement a fixed rate for your loan.
When it comes to variable rates, it is very difficult to anticipate the changes in the market.
If you are willing to take out a loan with extended repayment terms with the chance of saving over the term, choosing a car loan with a variable rate might be the best option for you.
Overall, there is a consensus that short-term, fixed-rate car loans are best as you will know what you need to pay every month.
Irrespective of the choice, bear in mind that you will get competitive rates if you have a good credit history and meet other eligibility requirements.