A zero-percent finance loan is a great deal for new-vehicle shoppers hoping to save money. In looking to jumpstart sales, manufacturers are relying heavily on zero-percent rates on terms as long as 84 months.
But is it really a good deal? Here’s are the pros and cons of zero-percent financing:
Will Zero Percent financing save money?
In a word, yes. “It is a great opportunity for consumers to save money on a monthly basis, make that vehicle more affordable or perhaps make it possible to afford a slightly different (or more expensive) vehicle than they originally had been shopping for,” Melinda Zabritski, senior director of automotive finance at Experian, said of the offers.
There is a long list of financial advice on the internet about taking the shortest term possible to reduce the amount of interest paid over the life of a loan. “That argument pretty much goes away with a zero percent rate,” Zabritski said.
Why are there so many Zero Percent deals now?
There’s a combination of factors at work right now. The Federal Reserve has cut rates to the bone to enable the economy to recover. Rising car prices and high loan amounts are a daunting obstacle for new vehicle buyers. Manufacturers note this affordability issue and use the low or zero-rate financing to keep monthly payments as low as possible. This also includes pushing out the terms of the loan from traditional 60-month to as long as 84-month contracts.
Evidence of rising vehicle prices, loan amounts, and monthly loan payments are clear. Kelly Blue Book reports Average Transaction Price (ATP) for light vehicles above $35,000. Part of this increase comes from consumers switching from traditional sedans to more expensive crossovers and SUVs.
Zero Percent, long terms keep monthlies in check
“We have loan amounts at an all-time high. Payments are at an all-time high. The lending market has been attempting to help reduce some of those payments through longer-term loans but of course, there still is the interest rate,” Zabritski said. Experian data shows the average loan for a new vehicle in the third quarter of 2019 was $32,480. The average monthly payment in that period was $550. That’s up nearly $50 from 2016. Payments had been relatively stable in the $460 range from 2008 was $506 for the purchase of a new vehicle, up from $493 a year earlier. However, the average monthly payment didn’t change much from the fourth quarter of 2008 to 2013.
If an automaker offers a zero-percent rate or an extremely low-interest rate on longer-term loans, “that is a great option for consumers to spread those payments over a longer time and not pay any incremental interest [on those extra payments]”, Zabritski said.
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What’s the downside of Zero Percent rates?
While it is literally money for nothing, there are some traps to avoid. Because it lowers your payment, there may be a desire to opt for a larger or more expensive vehicle. Not only does the upfront cost rise, but also there may be costs associated with lower fuel economy or higher insurance rates for the more expensive vehicle.
The biggest risk inherent in zero-percent financing is being seduced by maximum loan terms to minimize monthly payments. Taking advantage of that 84-month loan may be tempting, but depending on the vehicle, you could find yourself “upside-down” where you still owe more than what the car is worth for a long time.
“If they do choose a longer-term loan, and (later) decide not to stay in that loan’s long term, they will run into a negative equity situation when they go to trade that car,” Experian’s Zabrtiske said.
Qualifying is the key
The only big drawback to zero-percent financing, especially for buyers with lower FICO scores, is that not everyone qualifies for the loans. Zabritski stressed that you should also read the fine print on the automaker’s website for “some sort of credit qualifying statement. They might reference it as Tier 1 and Tier 2 customers only, Grade A customers only, something like that,” she said. Offers usually state “well-qualified buyers” in the fine print. Subsidized rates may apply to just a handful of models in dealer stock.
These zero-percent deals come through automakers’ finance subsidiaries. But the qualifications for loan approval can vary from make to make. A consumer may be approved for a zero-percent loan at one automaker and turned down that same day at another. “Unfortunately, consumers will not be able to figure out if they qualify until they are at the dealer applying for that loan because there will be more than credit scores they are going to roll into the approval process,” Zabritski noted. “Each one is different.”
Toyota Financial Services, for example, might have one credit score rating that would qualify a buyer for a consumer loan and Ford Motor Credit might have something completely different. Zabritski urges car and truck buyers to have a backup plan in the event they are rejected for a zero-percent deal. Before applying for that loan, they should contact their bank or credit union to determine the interest rate, loan terms and the monthly payment for that vehicle.
Other fine print in Zero Percent loans
The other factor to take into consideration is whether or not the zero-percent financing comes with conditions. Sometimes these deals are in lieu of rebates or other cash incentives. And some cash buyers looking to pay cash are wary at the 0-percent option fearing some hidden catch.
An Illinois Chevrolet dealer relates just that. A buyer eligible for an extra $1,000 in savings with the zero-percent loan was adamant on paying cash for a $40,000 pickup. “I said, sir, you are going to pay $1,000 more if you pay cash,” said the dealer who asked not to be identified. This $1,000 rebate is valid only if the buyer accepts a 0-percent loan. “He was bound and determined not to use it but I convinced him,” the dealer said. Arranging a minimum loan amount at the shortest term possible for the 0-percent loan gave the buyer the $1,000 applied to the purchase.
What should I look for when shopping for Zero Percent financing?
Being pre-approved by an outside lender sets a ceiling on the amount of interest you will pay over the life of the loan and gives the shopper additional leverage. Having this loan in your back pocket is insurance if you don’t qualify for zero-percent financing and gives you a rate for the dealer to beat with alternative financing or additional incentives.
Additionally, if the automaker is offering a choice of a zero-percent loan or a rebate, negotiate two separate deals. One should feature the no-interest loan and the other with the rebate plus a loan with interest. Remember also to factor in the trade if any, that amount should be the same regardless of the terms of the deal.
Even if approved for the zero-percent financing, there still could be a problem for the consumer. These contracts may limit the term to 36 or 48 months. This means a higher monthly payment. A 72- or 84-month loan with low interest from a credit union or bank might offer a more manageable monthly payment. But you will pay more for the car in the long run as a result of the interest and the extended terms.
What should I avoid when buying a car with a Zero Percent loan?
You should put as much as you can afford down on the deal. Skimping on the down payment will only add to your monthly cost or push the loan term out longer. As mentioned earlier, extended financing only erodes the residual or resale value of your vehicle.
Be sure to check the vehicle’s track record not only for resale but also for operating costs and dependability. While we advise against an 84-month loan, a shorter 60-month contract means you’ll be on the hook for this ride for five years. You want to make sure that the car is going to last without major repairs or erosion of its value.
