Variable rate loans for new car and truck financing are designed to attract new car buyers with a very low starting interest rate and extended terms. But variable rate loans may actually cost borrowers a lot more in the long run.
Variable Rate Loans - The Unknown
Variable rate auto loans are relatively new to the auto loan market. However, they are fast becoming very popular. This is because many lenders aggressively try to persuade customers to utilize variable rate auto loans. They do this by making the initial interest rate very low and tempting. Depending upon how interest rates fluctuate, the actual rate for this loan may increase as much as 5 to 10 percent over the life of the loan.
While some lenders are placing 5 percent caps or limits for increases on their variable rate auto loans, some lenders have no cap whatsoever. Where there is no cap, rates can increase to whatever level the lender feels is appropriate.
Recalculation
In addition, rates for variable rate auto loans are usually recalculated every month. Therefore, you may not see a large interest rate increase coming. Because variable auto rate loans usually also involve extended term lengths, the actual cost up for the loan is virtually impossible to determine.
Long Loan Periods
The problem with a longer term for an auto loan is as it gets paid off over a longer time period, more interest accrues, and you may have a hard time following any changes. In fact, with variable rate auto loans, it is not uncommon for some lenders to offer terms of up to 84 months. If the interest rate is increased once or several times, the actual cost of the vehicle could increase by thousands of dollars very quickly.
The Up Side
If you purchase a car at a point when interest rates are particularly high, and you think that interest rates might go down, then purchasing a car with a variable rate can save you some money. However, if interest rates go up--then the loan will cost you more. One advantage with these loans is that you have a latent period where the interest rate is not increased or decreased, irrespective of the market rate. Another economic safeguard that is built in is convertibility; you can convert your variable interest loan to a set interest rate.
Enlist a Loan Broker
Auto loan brokers have a lot of experience in assisting customers find all kinds of loans--including variable rate auto loans. Loan brokers don't get paid unless they can help you find a loan that meets your needs; furthermore, in most cases, loan brokers are paid by the lender they refer a customer to.
They usually work with many different lenders, and are not exclusively tied to 1 particular bank or auto loan lender; therefore they are an invaluable source of information for variable rate loans.
Choose Your Variable Rate Loan Wisely
If you feel that a variable rate auto loan is in your best interest, proceed with caution, and choose the best possible loan and interest rate available. Before signing documentation associated with a variable rate loan, always read the fine print carefully. Make sure you understand the maximum amount that the rate can be increased.
If there is no maximum interest rate increase cap, simply walk away. Your exposure to ridiculous interest rates and higher monthly payments is simply too great. Try to negotiate an interest rate percentage cap with the lender. If the lender is an honest and ethical company, the lender should be willing to cap potential rate increases to between 3 and 5 percent. You also want to make note of any lower limits. Some loans won't fall below the beginning rate, while others allow the possibility.
Look at the Loan Terms
With variable rate loans, it is important to look at all aspects of the interest rate on the loan. There is the starting rate, which is important. However, you need to consider other factors.
Under what circumstances does the rate vary? Could it change every 6 months or every month? This will be discussed in the loan terms. If the interest market is volatile and your loan is recalculated frequently, it is more difficult to budget.
You also want to know to what benchmark rate the variable loan rate is tied. For example, many are tied to the prime rate. They will be at prime or some number of points above prime rate. When the benchmark rate rises or falls, so does your payment.
Fixed Car Loan
Fixed rate loans stick with one single interest rate throughout the entire duration of the loan. While this provides you with a steady and secure payment plan, it can be frustrating if you end up paying a higher interest rate than other loans, as a result of fluctuations in the market. These are considered safer loans.
In reality, variable rate auto loans are usually not a good idea. However, if you must choose one, choose one where you have some control over the interest rates. Make sure that the loan term is not too long. Select a term with payments you can afford, but also one that will actually help you pay off the vehicle as soon as possible. After all, paying off your vehicle as soon as possible is always a good idea.
