What You Need to Know About Zero Percent Car Loans

A zero percent loan is 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.

And such loans aren't available to everyone: You typically have to have a credit score above 700 to qualify. If you can tick that box, you can get some significant savings: A buyer who gets a zero percent interest deal on a $25,000, 60-month loan would save $3,300 in interest charges, compared to a loan with the average 5 percent APR.

Lately, though, zero percent offers have become less plentiful. In August 2017, for example, 14.6 percent of car deals were financed with zero percent loans, according to Edmunds analysts. In August 2018, however, that number had dropped to 7.4 percent.

Rising interest rates are to blame. Zero percent loans are free money if you're the buyer, but not if you're the carmaker, which has to pick up the tab for such offers just as it does with traditional cash-back rebates.

Provided you can find and qualify for a zero percent car loan, it sounds like a no-brainer. But is a zero percent loan the best of deals? Are there any catches? And if you were planning on paying cash for your car, is it even worth considering?

How Can It Be Zero Percent?

Automakers' financing companies 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 has followed a pretty rigid pattern, said Jeremy Acevedo, senior analyst for Edmunds. Zero percent offers typically peak in the summer months to stimulate sales for the outgoing model year and stay "relatively subdued" in the other months. It remains to be seen if this pattern will continue in an era of high interest rates.

And while such carmakers as Chrysler, Nissan and Toyota largely walked away from zero percent loans in late summer of 2018, shoppers could still find the offers on selected models from carmakers including Ford, Subaru and Kia.

Carmakers advertise the no-interest loans in commercials, at dealerships or on their websites. The Edmunds Incentives and Rebates page also 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

As noted, 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 it's a good idea to call the dealership for the car you're considering to determine the requirements.

If your score is slightly lower, zero percent offers are still worth looking into. There have been cases of people, despite a lower credit score, getting approved because of a solid history of making payments on time and loyalty to a car brand.

Bonus Cash or Zero Percent Loan?

There are times when the automaker gives shoppers a choice between bonus cash or a loan with a very low interest rate. Bonus cash would usually be the way to go, but when it comes to zero percent loans, the cash has to be sufficient to offset the finance charges the buyer is saving.

For example, let's say you were buying a $30,000 car with a $3,000 down payment and you've qualified for a loan with an interest rate of 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 at least $3,575 to beat the zero percent loan offer. Any amount of bonus cash that's less than that 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: Take the bonus cash and refinance the loan later at a lower rate, assuming you can find one.

What's in It for a Cash Buyer?

If you planned on buying a car for cash (lucky you), 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 investments. 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 it's 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 preapproved 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 preapproval 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 that the combination of your bank loan and 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 20 percent, or as close as you can get to that figure, to offset depreciation. If you can't manage that, see if your insurance company offers new-car replacement insurance. If it doesn't, consider getting gap insurance.

Don't take out a loan for more than 60 months. Some automakers offer 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 shorter loan means you can drive a car you still love, free of monthly payments.