Fixed Rate Loan vs. Variable Rate Loan Terms for Cars

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November 9, 2016

Unless you plan to agressively pay down your debt, avoid a variable rate loan; get a fixed rate loan instead. Learn why fixed rate loans are preferred.

Although lenders have recently started offering car buyers what are known as variable rate loans, experts agree that fixed rate loans are a better bet for most borrowers.

The Variable Rate Loan
A variable rate loan is a loan where the interest rate can change, based on what's called the prime rate. Banks and other lenders follow the U.S. prime interest rate, which is a consistent across-the-board guideline for what the best borrowers would receive from a lender in an "ideal" case.

If a lender (such as a dealer) offers you a variable rate loan, that means the interest rate on the loan changes as the U.S. prime rate changes—meaning that it could go up. Without solid information on price caps or loan rate caps for a loan, you don't know how much the loan rate could rise. Also, without a good calculator, you may not be sure how that will affect the entire amount that you would pay over the course of the payment term.

Dealers may also offer variable rate loans for a longer term. The longer the term, the worse this deal can be for a borrower. Raising interest rates, with interest that is compounded and changed every month, could have a borrower "upside down" on a vehicle, or paying it off well beyond the lifetime of the vehicle.

The advantage of such a loan is that it gives you the ability to take advantage of a very low interest rate for the first year or so of car payments, which may translate to more savings. Interest rates are known to behave erratically, especially in today's tough financial times. You would have to accept the fact that the initial interest rate offered could be the lowest over the term of the loan.

The Best Time to Get a Fixed Interest Rate Loan
The best time to get a fixed rate interest loan is when the interest rate is predicted to increase. As a result, the borrower gets to pay a fixed rate, while the lender is assured of a profit on the money that is lent.

A few banks will offer 9 or 10 percent interest rates on floating loans, and this can go up or down. You will get about a 10.5 percent interest rate on fixed loans, which is of course higher, but it is fixed irrespective of the economy. Another point to note is that even if you do take a variable interest rate loan, a few lenders will offer you the option to shift over to a fixed interest rate. Check beforehand though, because in this case a fixed interest rate will have to be selected.

In an economy where interest rates are going to go down, you can opt for a variable interest rate. But if you want security, stick to the fixed interest rate that is more predictable.

How to Research Fixed Rate Loans

One method of comparing rates is to search online to compare several loan offers at once, but you'll often find better rates at a credit union or bank.

Gather Information
Gather information about yourself and the car you hope to buy, in order to compare rates and shop for a fixed rate loan. You don't need to have the exact car if you haven't yet settled on a specific one, although it helps. You can't get an accurate quote unless the financial institutions know all about your credit history and your current FICO score, and know details about the vehicle you want to purchase.

Call Credit Unions and Banks
With your information in hand, call a variety of banks and credit unions to get general rate quotes. The ones that seem the most promising are the ones where you should seek pre-approval.

Look Online
After comparing rates from local banks and credit unions, do an online search to see if you will get any better rates or terms online. Use an aggregator that gives you quotes from several companies to get a quick overview. If it appears you might get a better rate online, complete the pre-approval process with one of those lenders. Use online tools, like this one from BankRate, to get general figures on average interest rates, as well as the best rates for your region or area.

Compare Rates
You'll now have all the information you need to compare your fixed rate loan offers. Look at the interest rates and see who is offering the lowest rate. Consider the different lengths of loan you are offered, and see which gives you the best overall deal.

Choose a Short-Term Loan
Shorter-term car loans often have lower interest rates attached to them. That's because the lender doesn't have to wait as long for their money. These short-term loans also come with higher monthly payments, so figure out what your household can afford.

Go With Early Payoff Options
Paying off the car loan early will obviously decrease the amount of interest you're paying, and alleviate some of the interest that piles up with higher interest rates. You can also choose to refinance a loan with another lender, and bring interest rates down midway through a loan period.

Make a Large Down Payment
Making a large down payment upfront on your fixed rate loan generally brings the interest rate down. It decreases the total amount that you are financing, but it also signals to a lender that you're serious about your investment, thus lowering the credit risk and leading to better rates of interest. Play around with online loan calculators to see how a larger down payment gets you a better interest situation.

Consider how much you pay in the long run for the car, not just how much each monthly payment is. It may be better to make a slightly higher payment and pay off the car more quickly at a lower rate.

Fixed Rate Loans: The Best Bet
That best option for most car buyers is a fixed rate, short term loan, with payments that you can afford. Anything else can be a recipe for a continual drain on your wallet. That's why it makes sense to be skeptical about the new auto loan products that a dealer or other lender might offer. Choose a loan term that is suitable for your budget and type of car. Avoid longer than usual loan terms of up to 72-months, as this most often carries a higher interest rate than the usual.

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