With interest rates on the rise, zero-percent auto loans and their hard-hitting ads, hidden terms, and harsh restrictions have almost disappeared. In their place, a new low-interest offer has emerged, called a variable-rate auto loan. Hoping to snag unsuspecting consumers with the promise of a low start rate with extended terms, variable rate loans may cost borrowers more in the long run—a lot more.
Variable rate auto loans only recently entered the auto loan arena. Popular with some lenders because they force consumers to accept the risk of rising rates, these variable rate loans have a heavy downside for borrowers when interest rates head upward. While the lender usually puts a ceiling on how high the rate can increase—5% over the life of the loan, commonly—wise consumers do well to plan for a worst-case rate scenario. Rates are often recalculated every month, making it impossible to know exactly how much your loan will cost—or how long you'll be paying it off. While your monthly amount may not change, any increase in interest payments simply get added to the term of the loan—meaning you'll pay more interest and it will take longer to pay off the loan if rates continue to rise. If rates get too high and you decide to convert to a fixed-rate loan, be prepared to pay a conversion fee.
Lenders may entice borrowers to choose a variable rate loan by offering extended terms—sometimes up to 84 months. The resulting lower monthly payment may look inviting, but keep in mind that the longer the term, the more you'll pay in interest and the longer you'll be exposed to the risks of rising interest rates. In addition, as long as you have a loan on the car you'll be required to carry full insurance—an added expense you can avoid once you pay off the loan. While it may be tempting to own a more expensive car, extending the loan term just to afford the monthly payments may be a warning sign that you're heading for financial hardship.
Experts predict that the prime lending rate will continue to rise, affecting all consumer and auto loans. As you review your auto loan options, a good rule of thumb is to consider a variable-rate loan only if it is at least one full percentage point lower than the best fixed rate you can find. If you do choose a variable rate loan, insist on the shortest term you can afford, put as much down as possible, and keep a close eye on the market. Ask the lender for full details on rate caps, how they determine the interest rate, and how much it costs to convert to a fixed rate loan in the future. For more information on fixed and variable rate loans, contact our auto loan specialists at 877-254-WFCU, option 3.
Fixed rate loans are an excellent choice for borrowers when interest rates rise and market conditions become uncertain. A fixed rate guarantees that the interest rate, the length of the loan, and the monthly payments stay the same until the loan is paid off, regardless of the market's rate fluctuations. This offers consumers the security of knowing exactly how much they have to pay and for how long. It's easy to calculate the cost of interest over the life of the loan, an important factor to consider when determining the loan's real cost. Terms range up to 60 months, and there is usually no penalty or fee if you decide to pay off the loan early.
Marnée Evans writes financial articles for national banks, credit unions, and consumer credit counseling services, helping consumers improve their money management skills and learn to use credit wisely.