What is zero-percent financing?

An auto loan offer of zero-percent financing means the dealer financer is offering to lend the buyer money without charging any interest over the life of the loan.

With traditional loans, the lender is willing to extend money to the buyer because the lender will reap the benefits of the interest payments over the life of the loan. A zero-percent car loan, though, offers no reward for the lender. In fact, the loan is actually being offered by the auto manufacturer. The automaker stands to benefit from the loan as much as it would from an upfront cash payment for one of its cars. The only difference is that the money is earned over a longer time span. Automakers may offer zero-percent financing on slower-selling models or to help clear out stale inventory to make room for newer models.

Can anyone qualify for zero-percent financing? 

Zero-percent financing may be heavily advertised, but it can be difficult to qualify for one of these loans. They are typically only offered to buyers who have excellent credit, including a credit score above 700 and a long credit history. These buyers are more likely to make every payment on time and they may even pay off the loan early, making it low risk and profitable for the automaker.

It’s also important to note that not everyone can afford to take out a zero-percent financing loan. Since the lenders are only profiting from the actual sale on these loans, they will rarely agree to bargain down the price, nor do they offer any other incentives, such as cash-back rebates.

When is zero-percent financing a good idea?

For buyers who qualify, a zero-percent financing loan may be a way to save on steep interest payments throughout the life of an auto loan. A buyer can easily save several thousands of dollars in interest payments over the life of a zero-financing loan.

It is crucial that qualifying buyers crunch the numbers to be sure they can easily afford the monthly payments on a zero-interest loan. If all the numbers add up and the buyer’s credit makes the cut, a zero-interest loan can be a great way to save money on a new set of wheels.

When is zero-percent financing a bad idea

Zero-percent financing may not be in the best interest of buyers who can’t actually afford the loan. As mentioned, lenders generally will not bring down the price on a car with a zero-percent financing offer. Buyers may be blinded by the temptation of not paying any interest and therefore consider a vehicle that has a higher monthly price tag than they originally planned.

Another point to consider before committing to a zero-down financing loan is the term of the loan. Some of these loans feature longer terms than traditional auto loans, as much as six years. Six years is a long time to be paying for a car. The buyer’s auto needs may change before then and they won’t own the car for a year longer than they would have through a traditional loan. On the flip side, lots of zero-percent financing loans are only four years long, which can significantly increase the monthly payment amount.

Even if the loan terms do meet the buyer’s needs, it still may be worthwhile to skip the zero-percent financing and take out a traditional loan so the buyer will not miss out on cash-back rebates. These are typically not available on auto loans with special financing offers, and can mean missing out on robust incentives.

Let’s take a look at the purchase of a single car and run it through both kinds of loans.

A car is selling for $20,000 with the offer of a zero-percent financing loan that needs to be paid off in four years. Monthly payments on this loan will amount to $416.

Alternatively, the buyer can consider a traditional loan for the same car. An auto loan furnished by a credit union at the average national rate according to data extracted by the NCUA would give the loan an annual percentage rate (APR) of 3.45 percent. Over five years, this would amount to a monthly payment of $363.

In addition, with a traditional loan, the buyer can take advantage of manufacturer rebates. If this car would have an offer of a $2,500 cash-back rebate, its price would drop to $17,500. Through a Eagle Community CU loan with an APR of 3.45 percent, the monthly payments would only be $318. The total amount paid on the car would also be less than the amount paid through the no-interest loan, at $19,080.

If the buyer chose to take out a loan through a bank, with auto loan APRs averaging at 5.10 percent, the monthly payments (without the manufacturer’s rebate) would be $378. If the manufacturer offered a rebate, that amount would fall to $331 a month.

Evidently, when there is a shorter loan term involved, it is not always worthwhile to take out a zero-percent financing auto loan.

If the offer does not feature a shorter loan term, the difference between scenarios wouldn’t be as dramatic. A five-year loan on $20,000 with zero interest would cost the buyer $333 each month, only $15 more than the traditional loan through a credit union after the rebate; however, a five-year loan term may not be an option on a no-interest loan. Also, when you take out a loan through Eagle Community CU, you’ll enjoy personalized service and zero pressure to make a decision.

It’s best to run your own numbers through a free auto loan calculator to see what your actual monthly payment would be before taking on a loan. It’s the best way to determine if you can afford the payments without overextending your budget.

If you’re ready to get started on your auto loan, stop by Eagle Community CU today to get started. We’ll have you seated behind your new set of wheels in no time!

Your Turn: Have you chosen to forego a zero-percent financing option? Tell us about it in the comments.