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Buying a Car: What's the Catch With 0 Percent Loans?

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author photo by Doug DeMuro

If you're interested in buying a car, you've probably seen a lot of low-interest special offers and incentives from various automakers. Many brands offer 0 percent interest, which suggests that you can finance a car and pay no interest over the term of the loan. Does that offer seem too good to be true? It may be, as we explain below.

What Is 0 Percent Interest?

Before we cover whether 0 percent interest is too good to be true, it's important to explain precisely what 0 percent interest is. To do that, we'll have to get into an explanation of car loans.

When you take out a car loan, you're borrowing money to pay for a car; that much is obvious. But the bank doesn't give you that money for free. Instead, you have to pay what's called interest, a fee that you give the bank for lending you its money.

For 0 percent loans, you pay no interest. That means you're borrowing money from a bank but paying no fee for the privilege of doing so. Essentially, 0 percent interest gives you the chance to pay the same amount of money as a cash buyer, even though you're spreading your payments over a longer term.

How Is It Possible?

Since you're not giving the bank any incentive to lend you money, you might be wondering just how it's possible to get a 0 percent interest rate. The answer is that usually it isn't the bank doing the lending but rather the automaker itself.

The way an automaker can make money with a 0 percent deal is simple: It still earns the same amount it would earn on any car deal, but now the money is earned over a longer span. So the money isn't made on financing but rather the car itself. This means that 0 percent deals usually aren't a scam.

Bait and Switch?

While 0 percent financing isn't usually a scam, it can often be difficult to qualify for, and that's where many shoppers run into disappointment. Automakers or dealers will often advertise 0 percent interest, for example, even when it's only available to shoppers with the absolute highest credit scores and a long credit history.

When shoppers with only average credit reach the dealership, they find out that they don't qualify, and then they're presented with a higher interest rate that will earn more money for a dealer or an automaker. We wouldn't necessarily consider this a bait-and-switch scheme, since the 0 percent offer is technically good, but we would also suggest that you don't make the assumption that you'll get 0 percent financing in all cases.

What Can You Do?

If you've been enticed with a 0 percent interest rate, be sure to confirm that the rate is available once you get to the dealership. Next, take the car on a test drive and negotiate a good price. At this point, the dealer will look at your credit history to see if you qualify for 0 percent financing.

If the dealer explains that you can't be financed at 0 percent, you shouldn't necessarily back out on the deal. But you should think about whether you're comfortable with the new rate that you're presented with instead. If it's too high for your liking, remember that you have other options. You can always consider buying a car from a different dealership or visiting a bank to see if you can get a better rate somewhere else.

This image is a stock photo and is not an exact representation of any vehicle offered for sale. Advertised vehicles of this model may have styling, trim levels, colors and optional equipment that differ from the stock photo.
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Buying a Car: What's the Catch With 0 Percent Loans?