0% APR Car Loans: Are they worth it?

What is it with a zero interest rate car loans, is it legit or a scam? How do they make money on 0% car loans? Let's find out

Zero Percent Apr Car Loans

There’s a popular saying out there that says “if something looks too good to be true, it probably is.” So, when you are looking for a new car and you know you’re going to need to finance it, and you come across a dealership that has an offer displayed: 0% APR for 36 months; is that too good to be true? Is it for real?

In today’s blog, we are looking at the concept of car loans that come with zero percent interest for a fixed period of time and offering some insight into how they work, as well as their pros and cons. Read on and you might surprise yourself.

What is the Interest on a Car Loan?

When you take out a car loan, be it from the bank, a credit union or possibly from the car dealership itself, there is typically a rate of interest attached to it. If your credit score is very high, that interest rate will be very low, perhaps 2-3 percent, but if your score is bad then it will be a higher rate of interest, possibly 8-9 percent or even more.

This is how the finance company or car dealership makes money on your transaction, because in the end, and even though it takes several years, they end up with more money than they began. That concept of interest and making profit from lending is well known enough to most of us, but what it really does is make the concept of zero-percent interest on a loan all the more confusing.

What is a Zero-Percent APR Car Loan?

Car Loan Zero Percentage

The typical car loan is paid over a period of 3-6 years, with the majority being set at 4-5 years. Lenders and dealerships often prefer to talk about the loan in terms of months rather than years since payments are made monthly. The average interest rate on these loans, according to valuepenguin.com in March 2021 is around 5.27% over a 60-month period (5 years).

Understanding how interest rates work, then the only conclusion we can draw is that a zero-percent APR loan is one for which you pay no interest for whatever time period it states. Despite sounding too good to be true, this is in fact an accurate summary of what a zero-percent APR car loan is.

This means that if you get a zero-percent APR car loan over a period of 4 years, then the amount you have paid back after the 4 years is whatever the price of the car was. There won’t be any additional interest paid onto it.

Who Gives 0% Car Loans? How Do They Make Money?

Before we get to the pros and cons of these loans, let’s first clear up the mystery of why they even exist. If the point of lending money is to generate a profit from the interest, then surely a loan with 0% APR is the worst possible option to achieve that goal, isn’t it?

If you are running a bank or credit union, the answer to this question would be absolutely yes, because no matter how low their interest rates go, they will never hit zero for any more than a token period of time. The place you will find these zero-percent car loans over longer periods of five or more years are from one place — car dealerships.

Car dealerships offer these loans because unlike a bank they can make money in a wider range of ways. They also have the sale of the car itself as a way to generate money. If they give a zero-percent loan, but the car has a slightly higher-than-normal sale price, they still make a profit even if that profit takes longer to come in. They also offer the zero-percent deal as a way to entice customers to use their own car loans, thus securing a sale with a customer.

In the US, you are most likely to see the craziest-looking 0-percent APR deals when you hit the public holidays where big pushes for car sales are being made by dealerships. U.S. World News and World Report mentioned that for Black Friday in November 2020, some of the best examples included a 2020 Dodge Charger SRT Hellcat Widebody with 0% APR for 72 months, or a 2021 Toyota Corolla Hybrid with the same APR for 60 months.

Zero-Percent Car Loans – Pros and Cons

On the surface, anything with “0%” in terms of cost or interest surely has to be a good deal? What possible downside could there be to that? While these deals do have many positives, they are also some significant negative points that you should always consider carefully before you undertake such a loan.

Pros of 0% Car Loans

1. There’s No Interest

Yes, it’s an obvious advantage, but it can’t be ignored. There is a clear advantage to only paying for the cost of the car as it means that what you saw as the ticket price of the car is all you are paying. As a consumer, you have to take that as something of a victory to yourself that you will not be paying what is essentially “dead money” that is paid entirely to the benefit of the person who issued you the loan, in this case the car dealership. Many car buyers lament at how much interest they end up paying at the end of a loan period. With a zero-percent APR loan, you won’t have that to worry about that regret.

2. More Bang for Your Buck

It’s a bit of cliche, but the fact is that if there is no interest to pay, then you could afford to spend a little more and get a higher trim level or perhaps even a better brand or model of car altogether. If you’ve gone in search of a car with a budget in mind that includes the interest that you’d be paying every month too, then the lower monthly price with zero-percent interest means that if you wanted, you could get more car  for your budget. You could also just get the same car and pocket the difference, but the beauty is that these loans give you that luxury of choice.

3. Lower Monthly Payments

Should you choose to stick with the same car that you planned to get initially, then you can expect to enjoy a lower monthly payment. We can easily demonstrate this by using Toyota’s own Payment Estimator for a 2021 Toyota Camry. Let’s say we have two buyers:

  • John – a financial executive with a strong income and “Excellent” credit score of 720
  • Bill – a struggling artist working as a care assistant with a “Poor” credit score of 629

How would buying a 2021 Camry be different for these two? We’ll give them both the same buying conditions of a 60-month loan period and a $2,000 down payment and no trade-in vehicle. The difference in interest rate and therefore estimated monthly payment is stark.

  • John will pay an interest rate of 0% and $481 per month over 60 months
  • Bill will pay an interest rate of 11.84% and $640 per month over 60 months

In this situation, Bill pays $159 more per month than John, which adds up to $9540 more over the period of the loan that Bill pays compared to John. From here you can see the power of a zero-percent interest rate.

4. Potentially Shorter Loan Period

If interest isn’t going to be a factor, then you could ask for the loan period to be shortened and it might still be within your budget. If you could afford to make the payment with the interest, and the new monthly payment under a 4-year plan is about the same as that of a 5-year plan with interest, then why not take the shorter deal? It makes a lot of sense.

5. They’re Good for Car Dealerships

Finally, one benefit of zero-percent car loans also comes for car dealerships. It’s hard to imagine that this is true when they are making no interest, but it’s true. We touched on this idea further above, but for dealerships zero-percent car loans are an incredible marketing tool chiefly because it allows them to sell something that looks too good to be true but isn’t. There’s a lot of pull in deals like that.

Cons of 0% Car Loans

Now we come to the flip-side of the coin. Below are the potential problems with zero-percent APR loans.

1. You Only Get Them with Credit Scores

Our example above using John and Bill shows us that credit rating is extremely important when it comes to interest. The zero-percent loans are typically only available to those at the very top of the credit ladder. For many of us, that means a lot of credit building before we finally get there and can actually start enjoying the benefits.

2. Little to No Room for Negotiation

When you agree to a zero-percent APR loan term, you may well be giving away any and all power you have to get further concession during negotiation with the dealership. The dealerships will undoubtedly feel that they are already giving you a fantastic deal by not making you pay interest. What more could you ask for, right?

Dealerships know this all too well and may use the terms of the zero-percent APR loan as a way to raise the sale price and then offer no further incentives. You might be able still to negotiate the size of the down payment and possibly cancel some fees that you feel you the buyer shouldn’t have to pay, but that’s about it. There’s no room for discussion on the loan terms, sale price or other areas.

3. Potential Bear Traps of Missed Payments

Very often, a zero-percent APR deal that looks great on the surface and does deliver a no-interest loan to you may have  elements of risk underneath. For example, a common stipulation is that you cannot be even a little bit late with a single one of your 60 months of payments. If you are, then they may retroactively apply a rate of interest to the entire period of your loan.

It’s conceivable, therefore, that you get to having paid 57 months of your 60, but then you miss the 58th month and the dealership can go back over the entire loan period and apply a level of interest. Even if they only apply that interest to part of the loan. Suddenly your costs go up. With your top credit rating, that interest rate may still be low, but anything over zero is a blow after 57 months of paying at no interest.

Conclusion: 0% APR – Yay or Nay?

The truth is that with any financial commitment, regardless of the conditions, you should always read the fine print of the agreement carefully before signing. If on the surface conditions are very good and they’re offering zero interest the entire loan period, then underneath there may be more hidden conditions that could kick in should you fall foul of any small part of the agreement. Read the contract at least twice and understand all the conditions first.

If you have the credit score and they offer you a deal and you have a very secure income and savings to back you up in case anything goes wrong, then there’s no reason whatsoever to refuse any loan at zero percent. Proceed with care, but take the benefits where they come!