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Fixed Rate vs Variable Rate:

Which Car Loan Is Better?

· Personal Finance

When you buy a car in Malaysia, you typically have two options to choose from. One is paying cash the entire amount (easier said than be done) and another option is borrowing a loan from the bank. Though, paying the total amount with cash is the simplest way of getting things done, most of us don’t have huge amounts of cash in our bank accounts, so taking up a loan is the most common form of financing when buying a car. 

In this instance, the borrower (you) signs a deal with a lender (the bank) for an agreed-upon sum to purchase a car. In exchange, the borrower is indebted to pay back the loan amount plus interest because the lender needs to earn a profit from providing the loan. For a majority of car buyers, a hire purchase loan is the go-to solution that helps them land a new ride. Generally, when you apply for a hire purchase loan, you can choose whether you want a fixed rate or a variable rate. 

But, what are the differences between the two types of car loans, and is one better than the other? Well, below we got all the details for you.

Firstly, Let’s Start With What Make Up a Car Loan

Below are the key aspects that you need to know about car loan

1. Borrowed amount: 

This is principal amount that the bank is willing to loan to you to purchase the car, which follows an agreed-upon margin of finance of up to 90%.I

2. Interest rate:

 Presented as a percentage, this is the profit that the bank wants to make for providing you with a loan.

3. Downpayment:

 This is the upfront payment that covers part of the car’s cost, which is usually 10% for new cars and 20% for used cars.

4. Loan period: 

The amount of time taken to pay off the loan, which can range from as low as one year to a maximum of nine years.

5. Instalment amount:

This is the amount that is typically paid monthly to the bank to clear off the loan.

The instalment amount is what most people are concerned about, and it covers both the repayment of the borrowed amount and interest charged. It’s important to note that with hire purchase loans, the bank is actually in “possession” of your newly-purchased car, as you technically haven’t paid for it in full. So, if an individual fails to make the repayments over a certain period of time, the car can be repossessed by the lender.

How Does a Fixed Rate Car Loan Work?

Fixed rate car loans are the most common among car buyers, where the interest is calculated based on the principal amount borrowed and the length of the loan period. With this, your monthly instalment remains fixed from the start and stays that way until the end of the loan.

With everything pre-calculated, it’s all rigid and your repayments do nothing to reduce the total interest you have to pay. This is why it’s always said that there’s no point paying more than the monthly instalment when servicing a fixed rate car loan, as the payment will merely be considered an advance for the following month.

 Say you finish paying a five year loan in two and a half years through monthly payments, you still pay for all the interest owed to the bank – in this case, the bank simply takes all the interest earlier. Some banks do allow you to settle the loan early if you happen to have some extra cash on hand, although early settlements can be met with a rebate (or penalty in some cases) depending on the circumstances, so you’ll have to check with your bank before you decide to do so.

How Does a Variable Rate Car Loan Work?

Compared to a fixed rate car loan, a variable rate car loan calculates the interest based on the base lending rate (BLR) stipulated by the bank. The rate is typically presented as “BLR +/- X.XX%” and is commonly higher than that of a fixed rate car loan. Though, it doesn’t sound very encouraging compared to the 3.2% of the fixed rate loan but a variable rate car loan does have a unique aspect that some car buyers might find appealing. 

Unlike a fixed rate car loan, the interest is calculated based on the reducing balance method. With this, the interest is calculated over time based on the principal amount after deducting what you’ve paid, which is somewhat similar to housing loans. The benefit is if you have some extra cash available, some banks provide you with the opportunity to reduce your interest by making extra payments toward the principal amount. Check with the banks to see if this is an option available to you.

So, Now Back to the Big Question. Which is Better?

Depending on what you want from your car loan, both fixed and variable rate car loans have their benefits. For those who prefer consistency and predictability, a fixed rate is the best option, as they know exactly how much they will have to pay monthly over the loan tenure. There are no surprises, no changes over time, nothing to catch you off-guard.

Meanwhile, those who prefer some flexibility and have the ability to fork out extra every now and then would find a variable rate to be beneficial, as you can potentially finish off your loan sooner and pay less interest. On the flipside, you’ll have to deal with commonly higher interest rates and possible BLR changes – good or bad – that come your way.

With loans, the longer the tenure, the cheaper the instalment, but you’ll have to pay more interest in the end, which is another thing to take note of. So, while a nine-year loan might be tempting, you could spend more to finance your new ride, which will invariably depreciate over time.

If you wish to change to a new car a few years down the line, you’d be far better off selling an existing car with one year of loan left compared to one with five years to go (i.e. four years into a five- or nine-year loan). Your car’s resale value would factor in heavily here too, but that’s a discussion for another time.

In the end, the type of car loan you take boils down to a matter of preference, but you should always do your research and check with your bank to ensure you are clearly informed before pulling the trigger. Do share your experiences with either fixed or variable rate car loans in the comments below, and point out anything of interest.