What you need to know about 0% finance

23 Aug 2021

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If you’re looking for a new ride, you have probably come across dealers spruiking loans with 0% interest.

It certainly seems like a great deal ‒ you get behind the wheel of a new vehicle, and you can repay the loan with no extra interest to pay.

You could almost say it seems like a free lunch!

Sadly, we all know there’s no such thing as a free lunch, so let’s have a closer look at what you are really getting.

What are interest-free car loans?

Just as it sounds, interest-free car loans are loans with no interest payments attached, meaning they have a 0% interest rate. Most interest-free loans are offered by carmakers through their dealerships, as an incentive to bring in customers.

How are 0% car loans different to other types of loans?

When you take out a car loan, you are usually obliged to repay the principal of the loan - which is the amount you borrowed, along with interest and any applicable fees. An interest-free car loan is different because you only pay back the principal, no interest. Despite that, bear in mind that you may still have to pay other hidden costs, such as fees and charges.

How do 0% car loans work

When you take out a car loan you enter a contract to borrow an amount of money that has to be paid back within a certain amount of time (the term), usually in regular repayments.

The length of the term varies and can range from 1-10 years, depending on the agreement you reach with your lender. As well as paying back the amount you borrow, you will also have to pay interest on the balance, at either a fixed or variable rate, plus any fees and charges.

The interest rate is expressed as a percentage of the amount outstanding, so if you borrow $20,000 at a 5% interest rate, you will be paying $1000 in interest per year, plus the amount of principal required to repay it in the agreed time frame.

If the rate is fixed, it will not change for the duration of the loan. If it is variable, the lender can change the interest rate if it chooses to during the term.

As the interest rate on a 0% loan is, obviously, zero, then you won’t have to pay any interest.

Pros

  • Don’t pay any interest

Cons

  • Inflated purchase-price
  • Less room to bargain
  • Shorter loan-term
  • Potential extra fees

What to look out for

There are lots of ways for auto dealers to recoup the money they are sacrificing when they give you an interest-free loan. These include inflating the price of the vehicle, refusing to bargain as much as usual, imposing high fees and stricter-than-usual terms and conditions. Let’s look at them one by one.

Inflated purchase price

An interest-free loan will save you money on interest payments but the downside is that you may end up paying a higher price for the vehicle itself. Lenders make their profit from your interest repayments, so if you aren’t paying interest, the easiest way to boost profit is to charge more for the car than usual.

Fees and charges

As with any loan, it is important to read the contract to identify any monthly or annual fees and charges. Lenders who offer zero rate finance may add extra fees, charges and costs into the purchase price to compensate for the lack of interest payments.

Less room for negotiation

If you are seeking interest-free finance from the dealer, they are unlikely to negotiate much on price. This is because the lender will usually add the money they would normally make from interest payments into the price of the car itself, and won’t let you negotiate a lower price.

Stricter loan terms

Car loans come with terms of one to ten years, but interest-free loans are likely to be at the short end of this. That is because the longer the loan runs for, the more the lender is losing in interest. They want you to pay off your loan fast. Unfortunately, a shorter term will mean higher monthly repayments for you.

Limited range

Customers may visit a dealership with the impression that they are able to get 0% p.a. finance on all cars only to find out that the vehicle they have been researching is not included in the offer. Dealerships often limit the offers to less popular models or cars that have been sitting in stock for a while such as previous year or demonstrator models.

Poor trade-in price

If you are looking to trade in your current car you may want to ask for a valuation with and without dealership finance.

Tough eligibility rules

To be eligible for the 0% p.a. finance offer you may need to meet strict lending criteria such as a large upfront deposit or have a perfect credit history. Other conditions may include needing to be a home buyer or having been in your job for a certain length of time. If you are a renter with short-term employment or an imperfect credit history you may be ineligible for the 0% p.a. finance offer.

What to ask before signing up for 0% car loan

There are a number of important questions you should ask before signing up for an interest-free loan. These include:

  • What will your total repayments be over the life of the loan? This is effectively the price the dealer is charging you for the vehicle.
  • Can you get the same car for a lower total price elsewhere, once you add in interest charged for a loan from a lender?
  • If so, is the dealer willing to match the lower price you can get elsewhere?

So before you speak to your dealership about finance, speak with one of our Australian based consultants to discuss your options.

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