When it comes to a fixed or variable rate car loan, unfortunately there’s no exact formula where you can punch in all your details and magically come up with the right choice for you. It ultimately all comes down to your personal financial situation and the features you’re after.
But never fret, learning more about how the two car loan options work could help you make an informed decision.
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What is a Fixed-Rate Car Loan?
A fixed rate car loan is a loan with the option to lock in (or ‘fix’) your interest rate for the entirety of the loan term (usually between one and five years). In other words, your repayments will stay the same from start to finish, regardless of whether the Reserve Bank (RBA) increases the cash rate or your lender hikes variable rates or rates on new fixed loans.
A fixed rate can be the right option for those who want cash-flow certainty. By knowing exactly what your repayments will be, you’ll be able to plan ahead and budget for the future.
There are also two types of car loans, secured and unsecured.
A secured car loan is one where an asset (most likely the car you’re buying) is used as collateral against the loan in the event you were to fail meeting your repayments. In this instance, the lender has the right to repossess the asset to recuperate any funds lost.
Whereas an unsecured car loan does not require you to use any asset as security. In turn, you’ll find unsecured loans will likely have a higher interest rate as the lender is taking a bigger risk loaning you money.
Pros and Cons of a Fixed-Rate Car Loan
Pros
- Security: You know exactly how much your repayments are each week/fortnight/month.
- Certainty: You can budget your household expenses knowing your car loan repayments won’t change.
- Protection: Should rates increase in the future, your repayments will be unaffected.
Cons
- Limited flexibility: Many lenders don’t allow for redraw facilities or may charge high fees if you’re looking to pay out the loan early, refinance, or make extra repayments. For example, if you want to put a wad of cash from your tax return onto the car loan, this may not be possible.
- Interest rates fall: If interest rates drop, you could be stuck paying more interest than a variable-rate car loan. In other words, you could miss out on a better deal - you may be able to refinance the loan, but this might come with fees.
What is a Variable-Rate Car Loan?
A variable-rate car loan has an interest rate that follows the market. It means your repayments could rise or fall over the loan term at the discretion of the lender. For example, you could find yourself paying $400 a fortnight at the start of the loan, to six months down the tracking paying $450 as the lender has increased its variable rates.
This is why variable-rate car loans are more uncertain than fixed-rate loans as there’s no limit to how many times your repayments could change. This can make budgeting for your interest payments more difficult because you have to take into account potential rate rises.
However, variable-rate car loans do have appealing flexible features that may be too good to miss such as the ability to make extra repayments without incurring extra fees. Variable-rate car loans can also be secured or unsecured.
Pros and Cons of a Variable Car Loan
Pros
- Interest rate falls: Lenders may cut rates for a variety of reasons. If you’re on a variable rate, this means you’ll reap the benefits of lower repayments.
- Flexibility: Variable loans often allow for a winder range of repayments options including the ability to make additional repayments which could save you money over the life of the loan. It’s typically easier to adjust your repayment frequency, pay off the loan early, or refinance - without attracting hefty costs.
Cons
- Exposure: Lenders can change a variable interest rate at any time. For borrowers, this means their rate is likely to fluctuate over the life of their loan. If your bank raises rates, your repayments will also rise.
- Cash flow uncertainty: Harder to budget and make plans for the future as it’s impossible to predict when/if your rate will go up or down and by how much.
How to Compare Car Loans
Choosing which car loan you’re after - fixed or variable - is not a decision to make lightly as it could have a big financial impact down the track.
If you’re after predictability, a fixed-rate car loan may be the option for you. If flexibility is something you value, than a variable rate may be the right choice. The decision eventually rests on a thorough evaluation of your finances (current and future) and appetitive for risk.
Before you apply for a car loan, consider the following:
- Interest rate - Determines how much your monthly repayments will be. The higher the rate, the more you will have to pay in interest over the life of the loan. Interest rates are generally lower for secured, variable-rate loans.
- Fees - Many car loans will have additional fees that you’ll need to pay on top of your interest and principal repayments. Fees will vary from lender to lender and may include application fees, early exit fees, ongoing fees, or redraw fees.
- Features - Some lenders may offer redraw facilities or allow additional repayments at no extra charge.
- Loan term - How long do you want a car loan for? A longer loan term will mean your monthly repayments are less. However, you will end up paying more interest over the life of the loan. A longer loan may also mean that your car will depreciate more while still under a finance arrangement. At the same time, it’s important to choose a loan term that isn’t going to put you in a tough financial position.
