Fixed-rate car loans explained: Is it the right choice for you?

So, you want to buy a car and have even shortlisted the models you think are perfect for you and fall under budget. Now what’s next? After finalizing the vehicle you want to bring home, it’s time to plan for car financing. You can buy a car by paying in cash or through financing, i.e., a loan from a bank or any other financial institution. While the former is not everyone's cup of tea, having so much lying around ideal is a rare occurrence, and therefore car financing becomes one of the most common ways of buying a car.

But did you know that both buying a car via cash or financing has its set of advantages and disadvantages, which you can check out here? Anyway, our focus is on car financing or car loans.

There are different types of car loans that a lender offers -

• Fixed-rate car loan
• Variable rate car loan

The most common car loan is the former, and today, we’ll discuss fixed-rate loans in detail. But before that, let’s first understand loan interest rates a little better. As you can guess, fixed- and variable-rate loans correspond to fixed interest rates and variable interest rates, respectively.

Basics of loan interest rates

What is an interest rate? It is the amount charged on top of the money borrowed. Usually, it is calculated as the percentage of the total sum borrowed.

Factors affecting loan interest rate -

While calculating the interest rate on a loan, the borrower considers several factors like the loan term, loan purpose, and type of loan.

Did you know that the interest rate on a loan is affected by the type of loan? For example, the interest rate on a car loan is higher compared to that on a personal loan.

What is a fixed-rate car loan?

A fixed-rate car loan is one where the interest rate remains constant throughout the loan term. Thus making sure that the borrower’s monthly payment remains constant, irrespective of the market conditions or fluctuations in the market interest rate.

How does a fixed-rate car loan work?

As we have learned, a fixed-rate car loan has a set interest rate that is applicable for the entire duration of the loan which typically is around 36 to 84 months in the Philippines. The interest rate the lender charges is different for every borrower and is calculated through risk-based pricing; meaning a higher interest rate for a risky candidate who is more likely to default on the loan.

What is risk-based financing?

It is a tool that lenders use to determine interest rates and other loan terms based on the applicant's creditworthiness, i.e., via credit score.

However, risk-based pricing isn’t sufficient as having a low credit score does not mean the concerned applicant will default on a monthly payment. Therefore a lender also looks into other factors to get an idea of an applicant’s creditworthiness, including -

• Debt-to-income ratio (DTI = Total monthly debt payment divided by monthly gross income)
• Delinquencies
• Recent credit inquiries
• Bankruptcies
• Foreclosures & short sales
• Collection & charged-off accounts

After calculating the fixed rate of interest, it’s time to calculate the monthly payment which is based on the following -

• The principal amount, i.e., the total loan amount
• Interest rate
• Loan term

Example: If you have taken a car loan of PHP 1,500,000 with a fixed interest rate of 8% per annum for seven years, your monthly installment will remain the same from the first to the last month of the loan term.

Advantages and disadvantages of fixed-rate car loan

Advantages

A fixed-rate car loan is a popular choice among Filipino buyers as it comes with several advantages, part of them are -

Stability - The monthly payments you make under a fixed car loan are predictable, which is its biggest advantage. As the interest rate remains constant, the monthly payments remain undisturbed, thus making it easier for the borrower to plan your expenses and budget.

No worry of market fluctuations - With a fixed-rate loan, the applicant is protected against the rising interest rate (due to economic growth or inflation). This ensures that the borrower doesn’t end up paying more due to a hike in interest rate.

Secure & affordable - For someone looking for a car loan with longer loan terms, it is best to opt for a fixed-rate loan. Why? They offer security and affordability regardless of the economic changes in the country.

Simplifies budgeting - With fixed-rate loans, the monthly payment remains the same which allows borrowers to do financial planning well in advance which can be a mix of savings, expenses, and investments.

Disadvantages

Like a coin has two faces, a fixed-rate car loan also has its set of ups and downs; after knowing the former, it becomes crucial to look at the downs - so that you can make a sound decision.

A higher rate of interest - As is known, fixed-rate loans do not let lenders benefit from increases in the market rate of interest. This is why lenders usually keep interest rates high compared to variable-rate loans.

Not flexible - If there is a drop, the borrower may end up paying more compared to a variable loan candidate. It is only via refinancing that they can take advantage of the lower interest rate, however, this option comes with its own set of requirements and costs.

Less or no benefit of prepayment - In a fixed-rate loan where the interest rate is decided at the beginning of the loan term, lenders usually factor in total interest due, in case the borrower decides to repay the loan early. Furthermore, there’s the possibility of a prepayment penalty.

Variable-rate car loan

What is a variable-rate car loan? In contrast to fixed-rate car loans, here the interest rate may change periodically. The interest rate is usually tied to an underlying benchmark, i.e., the lender’s prime rate which fluctuates as per market conditions. In simple terms, if the prime rate rises, the interest rate will increase, and therefore the borrower's monthly payment will hike.

Now that we know a little more about fixed-rate car loans and variable-rate car loans, it is time to make a comparison (as there is no easier way to understand and compare the two).

Fixed-rate vs. Variable-rate car loan

Parameters	Fixed-rate car loan	Variable-rate car loan
Interest rate	Fixed throughout the loan term	Fluctuates as per the market rate
Monthly payments	Predictable and remain stable	Not at all predictable, can be more in one month and less in another
Risk	Not much as there is no change in the interest rate	High risk, as the borrower can’t predict the next monthly payment
Perfect fit for	Best for borrowers looking for stability and want to do/are interested in long-term financial planning	Best for risk-takers, who do not want to miss out on a substantial dip in the interest rate (which can not be predicted)

Fixed-rate car loans - Is it the right choice for you?

Finally coming down to the big question, is a fixed-rate car loan good for you? We say that if you are someone who prefers stability over the volatile nature of things (especially when it comes to money) and prefers to plan your budget or financial planning well in advance, then this one is your cup of tea for sure.

On the flip side, if you are someone who is a risk taker and enjoys the adrenaline rush of the highs & lows of the market, then feel free to move on to variable-rate car loans. Here, you might get to enjoy the potential drops in the interest rate.

Tips to secure the best fixed-rate car loan in the Philippines

Tip 1. Compare, we know it is the most common advice around car financing but believe us it works wonders if done right and with conviction. By the end of all the hard work, you’ll be able to secure a fixed-rate car loan with the best interest rate and terms.

Tip 2. Check for hidden fees, one common mistake that many loan applicants make is failing to ask or pay attention to hidden charges or fees. Make sure to ask if there are any processing fees, prepayment penalties, along with other charges.

Tip 3. Work on improving your credit score, no matter the case fixed-rate or variable-rate, with a good credit score you’ll be able to secure lower interest rates and other favorable loan terms.

Bottom line

If you are someone who prefers consistent monthly payments, does not enjoy taking risks with volatile interest rates, and is interested in keeping the loan for the full term with the thought of refinancing - then a fixed-rate car loan is an option to choose. However, do weigh the advantages and disadvantages of both the fixed and variable-rate car loan options before committing to a car loan.

Also Read: Chattel Mortgage explained: A smart option for auto loan