If you’re looking for a new ride, you have probably come across dealers advertising loans with 0% interest. It certainly seems like a great deal ‒ you get behind the wheel of your new car, and you repay the loan with no extra interest. But of course, there’s always a catch.
Deals that seem too good to be true probably are. So, let’s take a closer look at what you are really getting with a 0% car finance.
What is a 0% interest or interest-free car loan?
Just as it sounds, a 0% interest rate or interest-free car loan is a type of loan with no interest payments attached. Most interest-free loans are offered by carmakers through their dealerships as an incentive to bring in customers.
Usually, a standard car loan is made up of the principal loan amount plus an interest rate charge. Over a fixed term, borrowers will pay off the principal loan along with interest. Meanwhile, in an interest-free car loan, borrowers will only pay off the principal loan when making their repayments. Despite that, bear in mind that you may still have to pay other hidden costs.
How does a 0% interest rate car loan work?
What typically happens with 0% interest rate car loans is that it’s only interest-free at the beginning of the loan. You’ll see an interest-free period for the first few months, but when that period ends, your loan will be saddled with high interest rates, which you’ll have to pay for the rest of the loan term.
There are 0% interest car finance arrangements that remain interest-free throughout the loan term. However, some dealers tend to overprice the value of the car and raise the additional fees associated with the loan to make up for the zero interest charge. Car buyers could end up paying more for their vehicle than they would if they were in a standard car loan.
What are the pros and cons of 0% interest rate car loans?
The main advantage of an interest-free car loan is that you don’t have to pay interest (mostly), but 0% interest rate car loans also come with a range of pitfalls, like having less room to bargain. This means you’ll have trouble negotiating for a better price on the vehicle or better loan terms.
Interest-free car loans usually have shorter loan terms as well as potential for extra fees. You could see higher repayment amounts even if you’re not paying any interest, making it harder to manage your loan.
What should you watch out for with interest-free car loans?
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 the ways a 0% interest rate car finance can cost you more than you think.
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.
Expensive fees and charges
As with any loan, it is important to read the contract to identify any monthly or annual fees. Lenders who offer zero rate finance may incorporate exorbitant fees or charge higher ongoing fees.
A good way to figure out if a lender is charging more fees than usual is by looking at the loan’s comparison rate, as this takes into account fees associated with the loan in addition to its interest rate.
Lower negotiating power
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 seven years, but interest-free loans are likely to be at the short end of this. That is because the longer the loan term, the more the lender loses in interest payments. They want you to pay off your loan fast. Unfortunately, a shorter term will mean higher monthly repayments.
Limited car options
Customers may visit a dealership with the impression that they are able to get a 0% interest rate car finance on any car, 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.
Tough eligibility requirements
To be eligible for an interest-free car finance, you may need to meet strict lending criteria, such as a large upfront deposit or having a perfect credit history. Other conditions may include needing to be a homeowner 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 this type of loan.
What do you need to consider before signing up for a 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?
Often, these interest-free car loans sound good on paper but don’t really save you anything in practice. They may even cost more than a standard low rate car loan because of the ongoing fees.
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