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What’s the Catch With Zero Percent Car Loans?

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 zero percent APR interest, which suggests that you can finance a car and pay no interest over the term of the loan.

However, is zero percent financing too good to be true?

What is zero percent interest?

Before we cover whether zero percent interest is too good to be true, it’s important to explain precisely what zero 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.

A zero percent car loan is a car loan where you pay no interest; you’re borrowing money from a bank but paying nothing extra for the privilege of doing so. Essentially, zero 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 zero percent interest rate. The answer is that it usually isn’t the bank doing the lending but rather the automaker itself.

The way an automaker can make money with a zero 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.

Another thing to consider is that the cost of financing is built into the price of the car. If you’re getting a zero percent financing car deal, you might have a hard time getting any other incentives on top of that which means the automaker is still pocketing a nice profit on the sale of the car itself despite not making any profit on the financing. If you have the cash to buy a car outright, you might be better off taking advantage of bonus cash incentives rather than zero percent financing.

Is it a scam?

While zero percent financing car deals aren’t usually a scam, they can often be difficult to qualify for, and that’s where many shoppers run into disappointment. Automakers or dealers will often advertise zero percent interest, for example, even when it’s only available to shoppers with the absolute highest credit scores and a long credit history. Buyers with excellent credit scores are likely to make every payment on time for the life of the loan and maybe even pay it off early which makes it worth it for the automaker to offer zero percent financing. There isn’t a lot of risk involved for the company doing the financing when the borrower has an excellent credit history.

When shoppers with only average credit or bad 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 zero percent offer is technically good, but we would also suggest that you don’t make the assumption that you’ll get zero percent financing in all cases. It’s like the dealership is using a financial product as a form of advertising to get people into the showroom. There are a lot of free online tools you can use to check your credit score to give you an idea if you’d qualify for zero percent financing.

When is zero percent a good deal?

Zero percent financing is a good deal if you can afford the loan. If you’ve had an eye out for a new car for a while, you’ve built a great credit score, you’ve crunched the numbers in your budget to figure out a monthly payment you can afford, and the perfect zero percent financing deal has shown up for a car on your shopping list, then it can be a great deal. Like with any financial commitment, it’s always good to do your homework ahead of time to avoid buying a car and taking on debt on an impulse. That is a recipe for buyer’s remorse and you could get stuck hating your new car and hating your new loan even more.

If you’ve been planning for a new car purchase and you’ve found a zero percent financing deal that you qualify for and is friendly to your budget, it’s a good way to borrow money with no interest.

When is zero percent a bad deal?

Zero percent financing is a bad deal if you can’t afford the loan. If you’re thinking about buying a new car just because a zero percent financing deal seems too good to pass up, you may want to pause and reconsider. Were you even looking for a new car or did you come across a great financing deal and get car fever? Even if you’re not paying any interest on the loan, can you make the monthly payments work in your budget? Are you comfortable with the risk involved with financing a car rather than owning it outright?

These are all questions that any new car shopper should consider. Our point is that you shouldn’t rush into a car loan that you can’t afford just because of an attractive zero percent offer that you’re afraid to miss out on. Automakers run deals like these all the time so there’s nothing wrong with taking your time to give some extra thought and planning to your next car purchase.

Another thing to keep in mind; don’t forget to make a good down payment. If you get a zero percent financing deal on a new car, but make a skimpy down payment with it, then you’ll be upside down on your new car (owing more on it than it’s worth) the second you drive it off of the lot and your new car becomes a used car. Being upside down on a car is never a good thing and it can mean more expensive insurance in the form of gap insurance which is intended to cover the difference on what you owe versus what it’s worth in the event that the car is totaled. A good rule of thumb is to make at least a 20 percent down payment on a car to avoid financial insecurity.

Another way that zero percent financing can be a bad deal is if it’s just too long of a loan. Sometimes these deals stretch out for as much as 72 months or six years. Six years is a lot of time to spend paying for a car, no matter how good the monthly payment seems. What if your automotive wants or needs change in less than six years, but you still owe money on a car that you bought because of a great financing deal? The shorter the term and the higher your monthly payment, the sooner you’ll own your car which is the most financially secure position to be in with your car.

How can I get it?

If you’ve been enticed with a zero 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 zero percent financing. There isn’t a certain credit score that’s set in stone that determines whether you qualify for zero percent financing, but generally a credit score of around 740 or higher is considered very good.

If the dealer explains that you can’t be financed at zero 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.

The bottom line

Zero-percent financing is a nice incentive for qualified shoppers already in the market for a new car. A zero percent financing deal shouldn’t be the sole determining factor in your new car purchase. If you’ve done all the right planning for your new car purchase and you find a zero percent deal on a loan that works with your budget, it’s a great way to save money on car loan interest.

Related Car Financing Articles:

Editor’s Note: This article has been updated for accuracy since it was originally published.

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