Zero-Percent APR Loans – The Good and the Bad

Zero-Percent APR Loans – The Good and the Bad

When we’re exploring any kind of marketplace, we are always on the lookout for the best possible deal. Getting the perfect deal on a car for most people means securing great terms on a car loan. There are several ways that they usually achieve that:

  • Shop around for credit
  • Preemptively build their credit rating before getting approval
  • Favor credit unions instead of banks
  • Look to qualify for a 0% APR car loan

That last point is going to the focus of today’s blog. We are exploring the world of what on the surface are being called no-interest loans, but that some consider “too good to be true.” Is a o% APR loan really zero percent? How does anyone make money if there’s no interest? Who is issuing these kinds of loans?

These questions and others are ones that we will endeavor to answer in today’s blog.

Background: Car Loan Interest

A huge number of Americans buy their cars on finance, both new and used. It has quickly become the regular way in which people choose to pay for their cars, spreading the cost over a period of 2-5 years. It has made buying cars more accessible to many more people, and has also created a very competitive market for auto financing.

Under regular circumstances, a car loan. The website found and published in March that the current rate of interest on the average auto loan in the US is 5.27% over a 60-month (5-year) period. That rate obviously varies depending on the credit rating of the person applying for the loan, but regardless of rating the interest is usually between 3 and 10 percent.

These loans are issued by the car dealerships themselves if they are able and authorized to do so, as well as banks, credit unions and some other sources. The rate of interest you pay determines how much extra you pay for the car overall by the time you’ve completed the payments years down the line. If you are charged the average of 5.27%, then after 60 months the total amount you paid would be 5.27% more than a person who paid cash for the car.

It’s quite common knowledge that interest exists as an incentive for banks and other financial institutions to lend out money that helps people make improvements in their lives, start businesses and so on. That’s all quite well known. That being said, it raises the question among the uninitiated as to why any lender would offer a zero-percent interest loan over any period, be it 12 months or 60 months.

What is a Zero-Percent Auto Loan?

When you spend so long looking over all the various loans and interest rates for which you qualify, things can start to look a little bleak. But what if you were suddenly offered a loan at zero percent interest over 48 months? What would you think of that? You might think it’s a scam, but it is a real offer and here is how it works.

When you get a zero-percent APR loan, it is a real thing and it does mean that you won’t pay any interest on the loan during that period. Let’s say you’re looking at a car and you are offered financing with 0% APR over 4 years. The monthly payment is calculated and you agree to it. After 4 years, you’ll have paid for the entire loan, but the final amount you’ve paid will be the same as that agreed-upon price. In that sense, the offer is completely legitimate and you have indeed borrowed money over a 48-month period without having to pay any interest on it.

Who Gives Zero-Percent Auto Loans? How Do They Make Money?

These two questions are the next two that naturally follow from the facts of a zero-percent loan. First of all, it should be noted that it is not banks, credit unions or other traditional lending bodies that are issuing these 0% APR loans. These are a creation of the auto dealerships as a way to attract business and get more people taking in-house finance instead of looking elsewhere. By locking the customer in on more services, the deal is better for the seller.

If you want to see the most outlandish deals with zero-percent interest, then all you have to do is head to a dealership around Black Friday or another public holiday, which actually are good times to get a great deal on new- and used-car financing. U.S. News and World Report featured some of the best deals from Black Friday in November 2020, and these are loans that would many any reasonable, rational person double take and suspect a possible scam:

  • 2020 Volkswagen Jetta – 0% APR for 72 months
  • 2020 Mazda3 – 0% APR for 60 months
  • 2020 Dodge Charger SRT Hellcat Widebody – 0% APR for 72 months
  • 2021 Toyota Corolla Hybrid – 0% APR for 60 months

So, if it is the dealerships offering you this kind of deal on a new car with no interest over as many as 60 or 72 months (5-6 years), how is it that they are still making any money? Don’t most dealerships sell these cars at the invoice price? How can they make serious profit on any sale if there’s not even any auto loan interest to fall back on?

Car dealerships are unique in offering these loans precisely because unlike banks and credit unions, they are not reliant on financial products with interest as a primary source of income. The dealership can build at least part of the financing costs into the selling price. They could throw in some additional accessories or services that come part and parcel, together making the deal much more profitable while still keeping the buyer comfortable, even feeling like they are winning. While they won’t make any money from interest, they’ll still make at least what they want to make, but spread over a longer period of time.

On top of that, when a dealership is offering zero-percent interest on the car financing, they have a great excuse not to offer any discounts or other incentives to buyers. While car buyers are so dazzled and relieved at the thought of paying zero interest, they pay little to no heed to other areas that may normally be discounted by the dealership to secure a sale but now will no longer be. This is why the 0% APR car loan is a unique product of car dealerships, and it is the dealerships who push them hardest. You’d be hard pressed to find a bank offering loans at zero percent, no matter how generous they are feeling.

Are Zero-Percent APR Car Loans a Scam?

There are things you still need to be careful about and watch out for, which we will discuss in more detail in the section on Pros and Cons of 0% APR car loans. To understand about their legitimacy, the answer is fairly straightforward. No, zero-percent interest loans are not a “scam.” As we have explained and demonstrated above, they do exist and when you understand that they are offered in the context of car dealerships (who have alternate revenue streams) trying to secure customers over other lenders and offer a complete package to customers, the idea starts to really make sense.

While they are not a scam, they still come with their own unique terms and conditions, and it’s important that people really understand what they are getting into before they sign for such an auto loan. That’s assuming they qualify, of course. Below we will get into more detail about the pros and cons of these zero-percent loans.

What are the Pros and Cons of Zero-Percent APR Car Loans?

Pros of 0% APR Loans

1. They Boost Sales

To be a bit unique, we’re going to offer a benefit of such loans from the perspective of the manufacturer and their partner dealerships. It’s actually good for consumers to understand the broader thinking behind these loans and why they are offered. From the dealership perspective, when you are under pressure to shift inventory as fast as possible, to meet sales quotas each month and each quarter, to ensure that no vehicle sits on the lot more than 65 days and to make room for new inventory from the new model year that’s going to start arriving in the fall, you need serious incentives. What’s a better incentive than a zero-percent loan?

Furthermore, these loans can boost sales without creating a financial loss for the dealership or manufacturer. A car sold even at a minuscule profit over a few years is still a car sold at a profit, and it’s far better than a car left gathering dust on an auto lot where sooner or later it will have to be sold or leased at a loss.

2. Lower Monthly Payments

Without the added burden of interest, your car payments become much cheaper. You can see the difference if you use one of the many dealerships’ finance estimate calculator to see what your monthly payments would be according to the given APR. We tried it with a 2021 Toyota Corolla with an MSRP just over $21,600.

With an “Excellent” Credit Rating (Score 720+), you can qualify for 0% APR and the monthly payment with a $3,000 downpayment and 48-month loan period comes to $483 a month. 

Switch that to a “Good” Credit Rating (Score 650-669), your APR is 5.9%, which takes your monthly payment to $543 when the other down payment and loan term conditions are the same.

That’s a difference of $60 a month, which over a period of 48 months means that a zero-percent APR loan has just saved you $2,880 dollars in all.

3. No Interest!

It’s worth pointing out that beyond just saving you money with lower monthly payments, it’s something of a consumer victory to not have to pay interest on borrowed money. Whenever you delve into the world of credit and borrowing, interest is the inevitable downside that makes people think twice about it. If the interest is taken away, then the deal gets a lot sweeter on the part of the borrower. It’s not like there is no downside at all, but not spending the four years thinking you’re throwing away good money on interest makes the deal very attractive indeed, and a win for the consumer.

4. You Can Get More Car

When you put together the above two reasons, a loan with no interest rates means that you can afford to borrow more. If your original budget was a loan for a certain amount and the amount of interest according to a typical APR of 3-10 percent, then the disappearance of interest means that there 3 to 10 percent more money you can still afford to spend on the car.

This won’t mean that you can jump from our example of the 2021 Toyota Corolla mentioned above all the way up to the likes of a Mercedes-Benz S-Class or Bentley Continental, of course. But what it could mean, in real terms, is that you could seriously upgrade the car you favor with a higher trim level, additional ADAS features, a luxury package, a premium sound system, leather upholstery and much more. It doesn’t take much imagination to quickly see how much scope there could be for more car when you could have as much as 10 percent extra to spend that would otherwise be going to pointless interest payments.

5. You Can Take a Shorter Loan Period

If you don’t need or want to upgrade the car that you’re buying by using the money you’re saving on interest, then you could do something else with those savings. One thing you could do is spend the difference anyway on a larger repayment that gets you done with paying the loan faster. If you can afford the price with interest anyway, then why not offer to pay more each month and pay off the loan in 3 or 4 years instead of 4 or 5 years?

You could of course always ignore both points 4 and 5 and just pocket the difference instead, and use it for something else.

Cons of 0% APR Loans

1. They Make Negotiation Harder

As we touched on above, many car dealerships feel like they are already doing you the best possible service when they offer you a zero-percent interest rate. While it would be the smart thing to do to keep negotiating for as much as possible, they have put themselves into a strong position because how can you argue with zero? When they tell you they’ve gone as low as they can, and that low is zero, how can you come back from that?

These loans are often used strategically by dealerships as a way to simplify the deal and justify their salespeople from having to offer further incentives. It’s not to say at all that you can’t do any better than zero percent on the APR, because there are other aspects of the loan to consider. These other aspects include the size of the down payment, the costs of additional extras, and the presence of some other added fees that you might think you shouldn’t need to pay for, and more.

2. You Need Top Credit Scores

In the example from Toyota that we showed you above, the 0% APR only applies to people with either a “Great” or “Excellent” credit score. The “Great” level starts at 690 and goes up to 719, and then “Excellent” is anything over 720. You don’t get to a score like that overnight. If you have anything lower than that, APR starts to kick in. For a lot of people, this makes the 0% interest rate harder to qualify for.

3. Added Penalties for Missed Payments

We mentioned further above about the potential addition of hidden terms and conditions within these zero-percent APR loans. You should read the fine print carefully before signing anything of course, but it becomes doubly important on any financial deal that on the surface sounds even a bit like it might be too good to be true. Zero-percent interest rates usually fall into that bracket.

One possible example of a condition you will be agreeing to is that if for any reason you are late with one of your monthly payments, then the loan will revert to a pre-agreed level of APR that may even apply retroactively to the entire period of the car loan. This kind of condition is common for credit cards and store cards that offer a fixed period where there is zero interest on purchases or money transfers. That would mean that while the pressure of interest payments had been removed, the ever-present specter of a sudden interest hike would always be looming if you missed a payment for any reason, even just a basic error of getting a date wrong in your payment calendar.

Conclusion: Zero-Percent APR – Friend or Foe for Car Loans?

As with anything in the world of auto financing, at the end of the day you have to make a smart decision that will work for you. It’s impossible for anyone to fairly argue against how good a deal zero-percent interest is, regardless of the terms and conditions. No interest is always a great thing when you’re borrowing money. If people go head over heels when they get a 2.4% APR instead of a 5.7% APR, then imagine how much elation there should rightly be when it’s 0% APR.

The key thing seems to be confidence in your ability to make the payments on the car loan for the entirety of the loan period. It is therefore a good idea for those taking on a 0% APR loan to have a contingency plan in place, perhaps through friends and family or through personal savings, to continue making car payments should anything bad happen. The current COVID-19 pandemic and the far-reaching economic consequences that it has had on the world should be lesson enough that we all of us need to be prepared for difficult times. 

Committing to 4 years of uninterrupted payments on pain of retroactive interest as a punishment for missing even a single payment is a serious undertaking. If you have the resources and contingencies in place for such things, then we say go for it.

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