Zero-percent Car Financing – Fact Or Fiction?
What does zero percent financing really cost? Car dealers have been very successful with their zero percent financing campaigns – so successful that the concept has been repeated in other industries such as electronics, furniture sales and credit card companies.
According to CNW Research, only one-third of buyers who apply for zero percent auto financing actually qualify and only 10% of those deals actually close according to the National Automobile Dealers Association. CNW Research goes on to state that many zero percent qualifiers overpay for their cars, since they assume they’re getting the best deal available and they fail to negotiate price. Automotive manufacturers use their own financing companies to underwrite these zero percent loans, each of which have their own credit qualifications. Generally speaking an applicant must have close to perfect credit to qualify for zero percent financing.
If you have been one of the fortunate ones that didn’t get lured in with the 0% financing offers only to get switched to a higher rate because of “blemishes” on your credit and the dealer is now offering you that “free” money, here are some drawbacks you should be aware of before signing that deal.
Shorter Loan Terms. Some dealers offer 60 month terms, but 36 months is average. This means your monthly payments will be much higher.
Limited Inventory. The zero percent offers are generally reserved for models that are suffering lower sales and is almost never offered on pre-owned inventory.
Cash Back. Have you every noticed the “or” clause in those zero percent advertising ads “0% or $10,000 cash back?” That $10,000 you lose by opting for the zero percent financing is the actual cost of borrowing. This often equates to an interest rate much higher than a traditional car loan.
Adding up the Numbers A recent search of the website of one of the Big 3 automakers shows an offer of zero-percent financing on a 2005 mid size sedan. This is how the numbers work out.
The Zero Percent Car Loan: What to Know Before You Sign
You’ve seen the ads on TV — zero percent financing on the car of your dreams! Should you bite?
These deals mean you pay no interest on your loan. Other incentives manufacturers and dealerships use to get people to buy include rebates (cash back) and low annual percentage rate (APR) loans.
A zero percent loan sounds too good to ignore. It’s free money, right? But keep these facts in mind before you sign on the dotted line.
You might not get the loan. Zero percent financing offers are available only to consumers with the highest credit scores, according to the Consumer Financial Protection Bureau. If your credit report is less than stellar, you may be out of luck. Once the dealership rejects you for the loan it may try to switch you to a higher APR. A win for the dealer, a loss for you if you were banking on free financing.
You’ll owe more each month. With most traditional auto loans, borrowers have three to five years —sometimes even up to seven — to pay it back. A zero percent deal, however, usually requires you to pay up in less than 36 months. The larger monthly payments could wreck havoc on your budget. What’s more, car dealers often require a substantial down payment for these loans — sometimes as high as 25 percent — so make sure you can afford that “free” offer.
You may miss out on better offers. A rebate offer will most likely come with a higher APR, but don’t let that deter you. If the dealer gives you a choice to take a rebate deal or take zero percent financing, run the numbers through an auto loan calculator. You may find the rebate offer would save you more money.
Before you find yourself at the car lot committing to a zero percent financing offer, take these steps to decide whether it’s right for you.
1. Check your credit score. Zero percent loans are reserved for people with an excellent credit score, which starts around 750. So even if you have a good rating, say around 720, you may find that zero percent financing offer becomes a two, three or four percent APR offer once you get down to discussions.
2. Know what vehicles the rate applies to. Often zero percent financing applies only to a select few vehicles. These may be last years’ models the dealership is trying to get rid of or brands that are selling slowly. Avoid buying a car that doesn’t suit your needs just to receive a special financing offer.
3. Calculate the total cost and compare it to other offers. Auto manufactures can afford to offer a zero percent rate because the cost is incorporated into the price of the car. In other words, they mark up the vehicle price to cover the cost of the interest they are losing on the loan. By increasing the overall cost they also increase the taxes you will pay on the car.
Shop around for better financing deals at your bank or local credit union and be willing to take a rebate offer instead.
4. Read all the fine print in the contract. Some zero percent loans come with special provisions that kick in after a grace period. Others may have stipulations if you default or are late on your monthly payment. Be aware of the charges you’ll have to pay if this happens.
Brian Fourman is a stay-at-home dad who writes about home safety and personal finance.
The Myth of Zero Percent Financing for Cars (John & Jane Jones Pt. 2 of 7)
Both Jane and John Jones were smiling as they walked into my office for the second meeting with them. The first meeting had gone well and I was excited to meet with them.
After a few minutes of catching up and pleasantries, I asked John, “If you were talking to a good friend and they asked what our office was doing for you, what would you tell them?”
John was contemplative for a moment and then started to speak. “Well the first thing I would tell them is that you have completely changed my thinking about whole life insurance and its value. You did not just convince me, but you helped me by using your special calculators, see the whole truth about how money works. In fact, I would probably tell them that your office has not tried to tell me what to think, but has rather helped me to learn how to think.”
“That is quite a compliment, thank you. I hope you have opportunities to say exactly that to people you care about,” I replied. “But I want to make sure you understand one critical thing: I never want you to assume my opinion to be correct. I want you to question everything I tell you. I want you to make your decision on your own – always. With that as a starting point, I want to approach an issue that I think is rather important. Are you ready to get into the serious side of our discussion today?”
Jane answered, “We definitely are! And, just so you know, my parents are so happy you helped us to see the wisdom in their decision to purchase that whole life policy for me when I was a year old. They send their thanks.”
I couldn’t help but smile. “Why thank you, Jane. That is very kind of you to report.” Getting a down to business, I told them about a recent study done by Lexis-Nexis. “Do you realize that 43% of American families own no life insurance? And of the 57% that do own it, 30% of those believe they have inadequate amounts of life insurance. Why do you think such a large portion of Americans are either under-insured or uninsured?”
“But I thought we were going to talk about purchasing a car – that is what we told you we wanted to talk about,” John said.
“Yes, I want to talk about that,” I replied, but humor me a little as I help you to see a very important financial truth. So why are so many people uninsured or underinsured?”
“Well, I guess it is because people have never met someone like you?” Jane said, almost questioning.
“Or maybe it is because they do not understand the value of life insurance,” John added.
“You are both on the right track.” I complimented them. “Have you noticed there is a disturbing trend in America that people do not understand the value of work?”
“Yes!” was their unified answer. “It seems that many of my peers do not know how to work or even value the fact that they have a job,” John added. “They just figure they can get another one if they don’t like what they’re doing or if something goes wrong with their employment.”
“It is a bit alarming, isn’t it?” I responded. “But an issue I believe is even more fundamental, is the confusion most people have about which of their assets is most important. What do you think most people would say is their most important asset?”
Once again both Jane and John answered together, “Their house.”
“You’re absolutely right – most people consider their home to be their biggest, most important asset. And it’s pretty safe to say that almost everyone has their house insured. But I disagree with that view. In fact, I think that perspective causes a serious lapse in financial judgment. A home – although definitely an important thing to have – is not the MOST important asset. The most valuable asset almost everyone has is the ability to earn their other assets. I believe – and tell me if you agree – that a person’s most valuable asset is their ability to work and make money. And yet very few have that asset protected sufficiently.”
John spoke up and said, “There you go again, helping us to see the bigger picture. When you put it that way, I can’t help but agree with you. I was surprised by the statistics you gave us, but knowing that information, it is even more surprising. Everyone should insure their best asset.”
“So then, how much insurance should they have on their most valuable asset?” I asked.
“As much as they can, of course. At least, that is what everyone does with their house,” John answered.
“I am so glad you said that John. Let me show you why. I want to show you another calculator called the Maximum Potential Calculator. I am going to use numbers for you both individually as you both are making about $45,000 a year. I am going to illustrate this until age 65. Let us assume that you will have a cost of living increase of about 4% each year.” Pointing to my computer screen I asked, “How much money will each of you potentially earn in those 41 years?”
“Wow that is a big number,” was Jane’s first comment. “Really? We are both on track to make nearly 4.5 million dollars by the time we’re 65?” Jane asked.
“Yes, that is the amount of money that will come into your life in the form of payment for your ability to work. Pretty valuable isn’t it?” I said. “There’s another important number to notice on this chart – what is projected to be your salary during the last year when you are 65?”
“$216,046. Wait, is that for real? It would be great to earn that kind of money.” John sounded a bit excited.
“Well John, let me ask you a question: will that $216,000 purchase more when you are 65 than your $45,000 salary purchases for you today?” I asked.
“Of course it will.” John blurted.
“Actually, the truth is this calculator shows the $216,000 salary you’d earn 41 years from now, is the equivalent of a $45,000 salary today.” I continued, “In fact you most likely will be able to purchase even less because of taxation.”
“That is depressing. But knowing that now can help me in the future. But what does all this have to do with our most valuable asset?” John inquired.
“The whole goal of home insurance is to replace your home if there is a complete loss. The same is true of life insurance. What is being replaced is your ability to work and earn money. In order to know how much life insurance you need, you need to estimate how much you will earn over time. Let me put this another way – what amount of money would you need in today’s dollars compounding at the same 4%, to be able to replace your ability to work and earn money? But we are getting ahead of ourselves. First, we need to look at another calculator, this one is called the cash flow calculator. Again using the same 41-year time frame we are going to use your net income ($29,250) instead of your gross income ($45,000) because the government will always get their share.” Pointing to the screen I asked, “what is the compounded value of your total net income?”
Looking for the red circle, John answered, “$7,367,704.”
“Great, but that is in dollars of 41 years from now. What we need is to know the present value of that amount in today’s dollars.” I quickly brought up a present value calculator and input the numbers. “What amount of money do we need today to make sure your ability to work and earn money can be replaced?”
“About a million dollars,” John said. After thinking a moment, John looked at Jane and said, “It looks like we each need an insurance policy for $1,000,000.”
“Yes, we do. We better do as we are learning and do the most important things first,” Jane said. Turning to me, she said, “We need to get going on protecting our family’s most valuable asset.”
“I am glad that issue is out of the way. I wanted to cover that with you before we got to your questions about purchasing a car. Like John said, we like to help our clients discover, learn and understand the whole truth about their financial environment. When you understand the whole truth, it becomes easy to know what decisions need to be made first. You two are great students and have a bright future ahead of you,” I said. “Now on to another important concept, purchasing a car….”
“Did you get the proposal we sent to you?” John asked. “You know that 0% interest loan seems like a no-brainer to me. But Jane really wanted to get your perspective before we made that purchase.” John added.
“I am so glad you did because there are a few nuggets of truth you need to understand. To start off, answer this question for me, ‘How does a car company make money?'” I asked John
With a puzzled look on his face, John answered, “By selling cars.”
With a little chuckle, I said, “You are right. But think further; why do all the major car manufacturers offer to finance your car for you? Is it possible they make money financing cars for people? In fact, the car companies make more money financing the purchase of cars than selling their cars.” I explained. “But then there is the interesting offer of 0% financing. If the financing is the major way they make money, why would they give that up?”
“I am not sure why they would, but isn’t that what they are doing with the 0% financing?” John answered and asked at the same time.
“How much does the car you are considering cost if you financed it with the manufacturer?” I asked.
“$35,000.” Jane volunteered. “Which will give us a monthly payment of $72&.17.”
“Great. How much will it cost if you pay cash or finance it through an outside source?” I asked.
John beat Jane to answer, “$32,500.”
“So the car company will give you a rebate of $2,500 if you pay cash and drive off with the car. Let me show you what the car company is actually doing by using my rate calculator. “I input the numbers, using the rebate cost of the car with the SAME car payment. I then asked, “What interest rate are they charging?”
“Yes, that is correct. By just raising the price they can call it 0% financing.” So here is the next question: should you purchase the car from the manufacturer, using your policy as collateral or should you finance it at the credit union?” I smiled as I asked them.
Thinking out loud, John said. “Well, at the manufacturer’s dealership our payment will be the same as at our credit union if they charge us 3.68%. But they have offered us a rate of 2.99%. So the better interest rate is at the credit union. I know using our policy is a great way to minimize opportunity costs.” Looking at me he then asked, “How much does it cost to get a loan from the insurance company?”
I wanted to jump up with excitement. At our first meeting, this 24-year man wanted to get rid of his wife’s policy, but now he wanted to use that policy to finance a car. “John,” I started “you are beginning to understand the real value of a whole life policy. But as I have said, a number of times, the whole truth is important. If you use your policy as collateral for a loan from the insurance company, the interest rate will be 5%.” I then waited to see what they would say next.
Again thinking out loud, but also looking at Jane, John said, “It seems to me that the credit union is the best way to go, unless I am not understanding something.”
“You are right. You have to remember that just because you have cash values doesn’t mean you have to finance everything possible using those cash values. You only use them when it is to YOUR advantage. This time, it appears the credit union is the best way to go,” I said like a proud teacher.
“Ok then, it is settled. This has been a great meeting. We will fill out an application for a $1,000,000 term policy for each of us right now. We will buy the car using the credit union as the financing tool and set up a time for our next meeting. Sound good?”