A look at 0% financing and the implications when buying a new car.
Whether you’re buying a house or putting a vacation on your credit card, you’ll have to pay interest. Not so with a new car and 0% financing. Financing a purchase on four, five, six, even seven times without paying any interest? Only the automotive industry can offer that.
Many automakers give buyers the possibility of financing the purchase of a new vehicle without charging any interest. Is it too good to be true?
You’ll Need a Calculator to Evaluate 0% Finance Options
Some calculations are needed to determine if the 0% financing is really advantageous. For starters, it’s important to note that interest-free financing isn’t the only promotion offered by automakers on the purchase of a new car. Often, you can choose between 0% financing or a rebate when you pay cash.
This same discount does not apply when we finance the vehicle. There may also be cash back combined with 0% financing, but the amount will be less than the cash purchase discount. Now, this is important because not all buyers need manufacturer financing. Some buyers have access to low-interest financing through a line of credit, for example.
The interest rate applicable to a line of credit can be very low, especially if we are talking about mortgage-backed line of credit with 3 or 4 percent interest.
If we have the option to use a line of credit to pay for new vehicle, then we are eligible for the cash rebate at the dealership. The total cost of the purchase taking into account the line of credit interest rate and the rebate must be compared with the total cost of the 0 % financing option to determine which option is the best value.
0% Financing Example
For example, imagine that a vehicle costs $30,000 after adding all taxes and fees associated with the purchase. This vehicle can be financed at 0% for 5 years by the manufacturer, but a $ 5,000 discount is also offered when we pay cash.
We are either paying $ 30,000 over 60 months, or $ 25,000 today. Let’s say we do not have the necessary funds, but we can still put the purchase on our mortgage line of credit that has a 3.5 percent interest rate associated with it.
In such a situation, the total amount of the purchase taking into account interest charged with the mortgage line of credit will be $ 27,287 with a monthly payment of $ 454.80 for 60 months. With 0% financing, the total amount will be $ 30,000 over 5 years with a monthly payment of $ 500. In this case, 0% financing is not advantageous.
On the other hand, if the interest cost of our line of credit is 8%, then the total amount paid after five years becomes $ 30,414 even with the $ 5,000 rebate. In this case, the 0% finance option is the more affordable one.
As you can see, the key to deciding if 0% financing is the right option is to compare total cost with other financing options available and the rebate we can get off the price of the car with those options.
Some Precautions About 0% Financing
Before signing on the dotted line, make sure the total cost at the bottom of the contract with taxes and everything included is the same amount as the actual price of the vehicle before any rebates. Although rare, some dealerships may inflate the price of the car that offers no-interest financing.
Ultimately, there are no real pitfalls with 0% financing and in many cases this is the best option to buy your vehicle. However, we must be vigilant and consider all the variables.