How Does a Zero Percent Deal Work?

It’s generally accepted by most people in this country that the events of September 11th changed many aspects of life, along with introducing stories of heroism and resiliency by families and first responders.

The economy also changed in the following weeks and months, and carmakers were not immune to the effects.

“Our challenge is to make sure we can stimulate the demand side,” said Rick Wagoner, CEO of General Motors at the time. Just eight days after those attacks from the skies, GM unveiled its Keep America Rolling campaign, offering free financing for up to five years to qualified car buyers. The intent was to kindle interest in automobile sales in an environment where a lot of people were thinking about pretty much anything other than buying a new car. The plan worked, goosing sales and forcing the likes of Ford and Chrysler to follow suit.

These days, 0% offers are flung around like rice at a wedding, with customers being presented with such advertisements on just about every form of media. But how does such a loan work? Is it available to everyone? Surely someone is still making money. The answers to these queries, as they are to most car-buying inquiries, requires a bit of explaining … except for the last question – you can always be sure that, in the car racket, someone is always making money.

At their core, 0% loans do exactly what they say on the package: provide funds to buy a car absent of any interest fees. Calculating the monthly payment is easy when all a person has to do is take the loan amount (principal) and divide by the length of the loan (term). For example, a $24,000 agreement at 0% over 5 years results in a monthly payment of $400. Easy.

What’s decidedly not easy is the myriad of traps and pitfalls one must watch for when shopping for these types of deals. Sure, 0% sounds great – who doesn’t like so-called free money? – but the real cost to such agreements is often a little more nuanced. We’re big proponents of doing one’s research before hitting the car lots, and reading the fine print once you’re there, meaning the smart consumer will know what they’re in for with a 0% APR car loan.

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Actually, let’s look at some commonly-used terms that generally accompany these types of discussions at a car dealership. The just-mentioned APR stands for annual percentage rate in this case and is often a trio of letters that roll off a sales rep’s tongue like water while describing the terms of a deal. It is the cost a customer pays each year to borrow money, inclusive of fees and expressed as a percentage – in this case, zero.

Here’s another three-letter acronym you’ll hear: OAC. This stands for approved credit and is often a hurdle for Joe Q. Public in securing that vaunted 0% financing. Since lending institutions are technically taking a risk every time they loan someone money, it is standard practice for them to charge interest on the loan as a vehicle for profit; as the risk someone presents increases, so will the total interest rate being charged. Be sure to see our article about interest rates for the skinny on why this happens and how banks offset risk based on your credit history.

Since the lender is (technically) not making any money off the loan in terms of interest, they are not likely to make this offer to someone with a poor history of paying back loans. If a person has missed past payments or defaulted on credit, the chances of a lending institution extending a low-profit loan to a high-risk individual is all but nil.

In other words, while a 0% financing offer is likely being trumpeted from the rafters by a dealership, don’t be surprised if you fail to qualify for the terms if you have a less than perfect credit history.

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You bet your sweet bippy they are. Notice how we used the term ‘lending institutions’ instead of ‘banks’ in the last couple of descriptions? That’s because the main way in which banks make money is – you guessed it – interest charges. The likelihood of finding a 0% loan at a traditional bank is somewhere between nil and nada. So how can these deals exist?

If you look closely, you’ll find that – in the current climate of 2021 – only certain car companies are making this offer. By and large, they will be the companies that also have an in-house financing arm, such as General Motors or Ford or Nissan who have captive lenders that are part of the overall company. In this manner, if the company doesn’t make much bank on the loan itself, it can make up for it on the selling price of the car.

This is done through a shell game that usually involves rebates. Let’s use a pickup truck costing $48,000 as a fictional example. Imagine that in the month of June, the manufacturer is offering 0% financing on this vehicle over five years. Basic math teaches us this will produce a payment of $800 per month. Fair enough.

Your buddy hears about the bargain you got on your $48,000 pickup and heads to the dealer in July for the same deal, only to find out the interest rate has gone up to 2.9%. However, the manufacturer is now offering $3350 in rebates since the next year’s truck will be here in August. Guess how much your buddy is paying for his truck, even though he didn’t get 0%? That’s right: $800 a month.

See the game? Since this particular car company owns both ends of the equation – manufacturing and financing – they can make up the financial difference on either side of the ledger. In both deals described above, each customer is paying $800 a month and the automaker is probably making about the same amount of money overall.

Even when 0% is on the table, it behooves the smart shopper to research or inquire about other types of incentives or rebates. This is where using a build-and-price tool ahead of time can pay dividends. There are times when a car company may offer no rebates if a customer chooses to finance at 0% but provide incentives if a customer wants to pay cash.

Of course, very few people have the financial liquidity to haul tens of thousands of dollars out of their savings and buy a car. The so-called ‘paying cash’ is usually just a reference to a customer securing favorable finance terms at their own lending institution. In other words, you got approved at your own bank for a certain amount of money prior to shopping for a car.

Here’s an example. Our imaginary economy car from the beginning of this article had a selling price of $24,000 and a monthly payment of $400 at 0% over the span of five years. However, let’s say there is a $2000 rebate on the same car for people who are ‘paying cash’. Car companies might do this for any number of reasons, such as trying to clear out a relatively unpopular model. Whatever the motive, it has the effect of reducing the price to $22,000. If a customer has secured financing for that amount at their own bank for 2.5%, they will have a monthly payment of $395 over five years.

See the difference? Even though customer #2 is paying an interest rate higher than 0%, their payment is lower thanks to incentives and rebates. This is why it is important to thoroughly and fully investigate available options before signing on the dotted line.

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In fact, these 0% financing offers (and various incentives or rebates) aren’t always offered across the board. Most customers know that attractive offers like these are usually reserved for outgoing models or so-called last year’s cars, ones that manufacturers are trying to move off dealer lots before new ones show up to take their place. This is doubly true for a model that’s being significantly changed, an alteration that could include major styling differences or a hot new engine. Car companies loathe having a new-and-improved model sitting right next to the previous year’s machine; it makes the old one look bad and tougher to sell.

What the average buyer generally doesn’t know is that these types of financing offers can vary across individual trim levels of the same model. Low-profit base trims, for example, might not have 0% financing on the table but a fully-loaded Limited trim may have that allowance. This is especially prevalent in the pickup truck market, a scene in which there are a myriad of trims and powertrains from which to select. Shop carefully and make sure you are taking advantage of everything that’s on the table. Your author has seen far too many scenarios where a sales rep has conveniently forgotten 0% or a particular rebate applies to one machine but not the other.

Also, be aware that while a dealer’s lot may be draped with banners announcing ‘0% financing, there’s a chance the offer is only being extended on short-term loans, such as those over 36 or 48 months. For many customers, that would result in unaffordable monthly payments, especially given the ever-rising sticker prices of new vehicles. In those instances, it’s a smart plan to carefully examine all lending options – including those from your own financial institution – to make sure you’re not spending more than necessary. Remember, always look at the total amount of money being spent on a vehicle, not just the monthly payment.

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