What’s the difference between fixed and variable car loan rates?
If you’re in the market for a new set of wheels, you’ll be given the choice of a fixed or variable interest rate car loan. To understand which option might be best for you, let’s discuss each option, the pros and cons, and more.
Fixed-rate car loans
The most common type of car loan, a fixed rate car loan means that throughout the life of your loan, the interest rate will remain the same. So if interest rates drop or go up, your loan will be unaffected.
Having a fixed rate can be helpful for budgeting and planning purposes, as you know that the repayment amounts won’t change for the life of your loan.
This means you won't be thrown off by any interest rate hikes, and your capacity to take on other financial commitments will remain. Additionally, you know exactly how much you’re going to end up paying towards the loan in both principal and interest.
To illustrate this with an example, let’s say you took out a $10,000 car loan with a fixed rate of 5% p.a. over a five-year loan term. Without taking into account any extra fees and charges, or any extra repayments or balloon payments made, we can work out that you’d end up paying back $12,500 over five years.
In most cases, there will be early payout penalties for making additional repayments or paying off the loan before the agreed term. However, this will depend on the lender and your specific agreement. If you’re able to make extra repayments, doing so could chip away from your interest paid and reduce the life of your loan.
Variable-rate car loans
On the other hand, a variable rate can fluctuate in line with market activity. So if interest rates fall, this should reflect in the interest rate you’re offered. But if interest rates go up, so should the interest rate on your car loan.
This can be a little more difficult to budget around, as repayments can go up or down depending on the interest rate you’re being charged. However, it can be beneficial if interest rates drop, as you’re not locked into a non-competitive rate.
Plus in most cases, variable car loans don’t come with an early exit fee or early repayment fees, which can end up saving you money if you choose to make extra repayments.
To illustrate this with an example, let’s use the same example as above but you had a variable interest rate of 5% p.a. for the first three years, but this rate drops to 4.5% p.a. for the last two years. In this scenario, you would end up paying back $12,400, rather than $12,500, over five years.
Pros and cons of fixed vs variable interest rate car loans
To provide you with a clear picture of the benefits and drawbacks of each option, let’s outline the potential pros and cons in the table below.
|Fixed rate car loan
|Variable rate car loan
Which loan type is more suitable for you?
If you’re not sure whether to go for a fixed or variable interest rate car loan, it might be best to consider your personal situation and what would work best for you.
Would it be easier to know how much you’re going to pay back over time and stick to that amount? If so, a fixed rate might be better suited to you. Or would you like the flexibility to make extra repayments, and the possibility of paying a lower interest rate? In that case, a variable rate might be more suitable.
In either case, it can be helpful to shop around and do your research. In doing so, you could end up finding a better interest rate, and avoid being locked into an interest rate and loan contract you’re not happy with.
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