Zero-percent loans are often advertised as one of the best deals you can get when you're buying a new car. You'll sometimes hear people call such financing "free money." It's not that exactly, but it's as close as you're likely to get. Zero-percent loans tend to grab attention, but they make up only about 9 percent of the dealer-financed car loans in 2015 to date, according to Edmunds data.
Provided you can qualify for a zero-percent car loan, it sounds like a no-brainer. But is it really a good deal? Are there any catches? And if you were planning on paying cash, is it even worth considering?
How Can It Be Zero Percent?
Zero-percent loans are typically offered by automakers' financing companies. They forgo the money they would have made on loans with interest in favor of selling more of a particular vehicle. This financing incentive can spark sales of a slow-selling vehicle or help clear out inventory to make room for cars from the new model year.
"The availability of zero-percent deals follow a pretty rigid pattern," says Jeremy Acevedo, senior analyst for Edmunds.com. Zero-percent offers peak in the summer months to stimulate sales for the outgoing model year and stay "relatively subdued" in the other months, he says.
Carmakers advertise the no-interest loans in commercials, at dealerships or on their websites. We suggest taking a look at Edmunds' Incentives and Rebates page. It highlights zero-percent financing offers and other promotions for the month.
Sometimes a dealership will offer its own version of zero-percent financing. In this case, the dealership opts to pay the interest on your loan, either to sweeten a deal or as an incentive for you to make a large down payment. It typically occurs when a buyer already qualifies for a loan with a low annual percentage rate (APR) and the amount being financed is a figure the dealer deems reasonable.
How To Qualify
Zero-percent loans are typically reserved for buyers with excellent credit. The fine print on automaker websites often says things like "for qualified buyers" or "based on Tier One credit." The language doesn't really spell out what that means in terms of FICO scores. And the range itself can vary from one automaker to another, so we suggest calling the dealership to see what the requirements are.
Just what is "Tier One" credit, for example? It's a FICO of 690-719, according to one Washington state Toyota dealership that posted its credit tiers online. But that's just one brand and one dealership's numbers. According to credit services company Experian, 752 is the average credit score associated with loans that have an APR of less than 1 percent. As a general rule however, if your FICO score is above 700, you should be able to get a zero-percent loan.
If your score is slightly lower, zero-percent offers are still worth looking into. There have been cases of people getting approved because of a solid history of making payments on time and loyalty to a car brand — despite having a lower credit score.
Bonus Cash or Zero-Percent Loan?
There are times when the automaker gives consumers a choice between bonus cash or a loan with a very low interest rate. The bonus cash would usually be the way to go, but when it comes to zero-percent loans, the cash would have to be sufficient to offset the finance charges the buyer is saving.
For example, let's say you were buying a $25,000 car with a $1,000 down payment and you've qualified for a loan with an interest rate of 3.5 percent. You then have a choice: a bonus cash incentive or a zero-percent loan with no additional discount. It would take an incentive of about $2,500 to beat the zero-percent loan offer. Any amount of bonus cash less than $2,500 makes the zero-percent loan the better option. Use this calculator to input your own scenarios and see what option works best for you.
There's also a third option to consider. Increasingly, consumers are taking the bonus cash and then refinancing the interest-bearing loan at a lower rate later, says Melinda Zabritski, senior director of automotive finance for Experian.
What's in It for a Cash Buyer?
If you planned on buying a car for cash, there might still be some value in taking out a zero-percent loan. The biggest benefit is that it allows you to keep your money free for other purposes, such as an emergency fund or for investment. There is no penalty for paying off the loan early. Having financed a car appears as a positive mark on your credit report. Buying for cash doesn't show up at all.
In some cases, the dealerships may be getting an incentive from the automaker to promote a zero-percent loan, so taking the dealer's financing may help you obtain a better price on the vehicle. The automaker typically pays the dealership a bonus on the back end of the deal, which in turn would allow it to be more flexible with the price. It isn't a common occurrence, but something you should be aware of in case it comes up.
Zero Percent Do's
Do make sure you really want the car. Just because a car has a zero-percent loan offer doesn't mean it is the right car for you. Make sure you test-drive it to be sure it fits your needs.
Do get pre-approved for a car loan. It is still a good idea to secure financing with your bank or credit union before you go car shopping. This pre-approval can serve as a backup loan in case you don't qualify for a zero-percent offer. It's also useful to have a loan in hand so you can compare its interest rate to the dealership's financing. You might decide your bank loan, and the dealership's bonus cash offer makes the most sense for you.
Zero Percent Don'ts
Don't skimp on the down payment. Some dealers may give you the option to put nothing down at signing. We recommend you put down as close as you can get to 20 percent. If you can't manage that, consider getting GAP insurance to offset depreciation.
Don't take out a loan for more than 60 months. Some automakers offer a 72-month loan to help make the payments lower, but there are many drawbacks to taking out a longer loan. The car's value will have greatly diminished by the time you finish paying for it. And there's a good chance you'll be tired of your 6-year-old car just about the time you make your last payment. A long loan may keep you from owning, free and clear, a car you still love to drive.
To find a dealership that knows how to treat shoppers right, please visit Edmunds.com's Dealer Ratings and Reviews.