0% APR Car Loans: The True Meaning Behind Interest-Free Financing Deals

We’ve all know people in our lives who have gotten a 0% APR car loan and have bragged about “how great of a deal it was!”

A 0% APR car loan seems like a great idea, especially when you really want that brand-new car. No interest, no problem, right?

While it’s true that you won’t pay any interest over the life of the loan, you’ll make up for it 10 times over in depreciation and opportunity costs.

Most people also don’t understand the true meaning and reasons why 0% APR deals exist in the first place, which makes it easy to fall into the trap of interest-free financing.

Car dealers use 0% APR car loan deals to trick people into buying too much car. Not to mention your new car will depreciate the fastest the day you drive it off the lot.

There are reasons that an 0% interest car loan sounds almost too good to be true!

As someone who works for a car manufacturer and just bought a new-to-me used car (in cash!), I know all the tactics dealerships use to get people in the door to make a sale.

This post will walk you through 4 reasons why a 0% APR car loan “deal” is always a terrible idea.

What is the Meaning of 0% APR Car Deals?

A “0% APR deal” essentially means that you borrow money for free. APR stands for “annual percentage rate” and represents the interest rate that you are charged for borrowing money.

Interest is the cost associated with borrowing money.

No one is going to lend you their hard-earned cash with no return! Instead of holding onto the money themselves, they give it to you because you end up paying them back more money in the future.

Banks, credit unions, and other lenders need an incentive to lend you the money instead of keeping it.

So what’s the catch behind 0% APR deals if the lender doesn’t get a return on the money they’re lending to you?

Let’s dive into it!

4 Reasons Why 0% APR Car Financing is a Bad Idea

1. Why 0% APR Car Loans Exist in the First Place

Before we get into the 4 reasons why you never want a 0% APR deal on a car, it’s important to understand why 0% APR car loans exist in the first place.

You can only get 0% financing when you buy a new car.

The reason why these loans exist is because they are subsidized by the car manufacturer and only available at new car dealerships.

Ford, Chevy, and Toyota want to sell you a car so badly because they make SO MUCH MONEY off of new car sales. They don’t need you to pay interest, as long as the dealer makes a sale.

Car manufacturers know that a “0% financing” tagline gets people in the door to buy cars that they really can’t afford and don’t need. It’s almost predatory, really.

A bank or credit union will never give you 0% financing on an auto loan because they need an incentive to loan you the money instead of hanging onto it themselves. Car manufacturers will often forgo this incentive because they make so much money off the sale of new cars to dealerships.

Dealerships buy inventory directly from the manufacturer, so Honda has made their money before a customer buys a vehicle. The manufacturer really wants to move those vehicles to make room for the dealer to purchase new inventory fresh off the line (where the manufacturer makes money).

Enter the 0% APR car loan “deal” to get people in to buy cars they otherwise would not buy.

Trust me, I work for a car manufacturer.

Rule number 1 of car buying: If it sounds too good to be true, it usually is.

2. The Hidden Cost of Depreciation

It’s no secret that cars depreciate. They depreciate the fastest in the first 3 years.

People don’t understand that the value their cars lose over time is a cost that they absorb. If you buy a $30,000 car brand new, it’s only going to be worth about $18,000 in 3 years! Take that difference ($30,000 minus $18,000) and think about what you could have done with an extra $12,000 over the course of 3 years.

Probably a lot. After 10 years, your $30,000 new car is now worth about $5000. That’s $25,000 you could have invested, saved for a home, or paid off debt with!

Getting in the habit of trading in new cars every few years is what really messes people up. You purchase a new car, ride the steepest part of depreciation curve down, and then trade it in and do the same thing over and over!

Newsflash: depreciation still occurs even if you have 0% financing.

Even though you won’t be paying interest on a 0% APR car loan, the depreciation cost is insanely high. New cars are the absolute worst for depreciation, and the reason why you shouldn’t be buying brand new cars until you can actually afford them.

My personal requirement for that is having a one million dollar nest egg and a paid-off home. I’d rather have my money being invested into appreciating assets to build my net worth instead of having a brand-new car.

The only way to get a 0% APR car loan is on a brand-new car, and brand-new cars get hit the hardest with depreciation. See the catch?

3. They Encourage You to Buy More Car Than You Can Afford

Another huge reason why you should be wary of 0% financing is that it encourages you to buy too much car.

Using the “I’m not paying interest” excuse to finance a $40,000 car when you’re only making $60,000 a year is not cool. I see people do it all the time.

It’s almost predatory to send someone making $40,000 a year home with an $800 monthly car payment.

So, how much car can you afford?

This really should be phrased as “how much car should you afford?” You’ll find a ton of articles explaining what car payment you can afford with no explanation of depreciation.

Just because you can afford the payments, does not mean that it’s a good long-term financial decision!

Some experts say to never have the value of all your cars be more than half your gross annual income. But if you are a single person making $60,000 right out of school, a $30,000 car is way too much!

I’d say to aim somewhere around 25% of your gross annual income. Therefore, if you make $60,000 a year, a $15,000 car at a maximum should be plenty for you.

We’ve talked about how cars always go down in value, so the goal here is to minimize the amount of money spent on things going down in value.

You don’t always have to have a car payment!

Always having a car payment (including 0% interest car payments) is what is keeping the average American from a comfortable retirement. Invest that $500 car payment every month for 35 years and you’d have over one million dollars!

The best way to buy a car is to pay cash for a 3-5 year-old used one. This minimizes your depreciation cost and ensures that you don’t spend too much. It also means that you’ll have a safe, reliable car to drive for the next 10+ years.

It would be really difficult for someone making $60,000 to save up $30,000 in cash and spend it on a car instead of a home downpayment.

Saving in cash makes you really think about your decisions, which is a good thing! Having $30,000 and wondering what you could do with that money instead of buying a new car is called opportunity cost. It is super important to consider opportunity costs when making large financial decisions!

If people had to pay cash for their vehicles, a whole lot less of them would be buying new cars. A little bit of planning ahead and saving can go a long way.

If you know someone who always has a car payment, ask them if it’s worth one million dollars from their future. So many people don’t realize what repeatedly spending too much on vehicles does to their future!

4. It’s Easy to Get Underwater on Your Loan

Being “underwater” or “upside-down” on your car loan means that you owe more than the car is worth.

It is really easy to get underwater on a 0% APR deal! Since you’re not paying interest, there isn’t a big incentive to put a large amount down at the time of sale.

If you put no money down on a new car, you will be underwater immediately because of depreciation. Being underwater on a car loan is huge risk.

Let’s say you buy a new car with no money down, and 3 months later you get in an accident and total the car. (No one was hurt, don’t worry!)

Your insurance company will give you what the car is worth TODAY, NOT what you paid for it. Since you put no money down and the car has depreciated so much, let’s say you are $5000 underwater. You owed $5000 MORE than the car was worth, and now there is no car.

Your insurance company writes you a check for $5000 LESS than what you owe on the car (fair market value), you have no car, and you still have a $5000 loan to pay back. Ouch.

GAP Insurance

If you’re planning on financing a new car with a low down payment for more than 4-5 years, your loan provider will likely require you to purchase GAP insurance on top of your regular car insurance.

GAP stands for guaranteed asset protection and covers the difference between what you owe on the loan and the fair market value of your car if you’re in an accident.

The cost of GAP insurance varies based on your age, driving record, and location. In the example above, the GAP insurance would cover that $5000 difference.

GAP insurance is such a ridiculous concept to me. Your loan provider agreed to lend you the money for a depreciating asset. They know you’ll owe more than it’s worth almost immediately. Instead of telling you “hey, this is a terrible financial decision and too much of a risk for us, we aren’t going to lend you the money unless you can put $X,XXX amount down so you’re not underwater,” they make you pay more for extra insurance.

What?

Banks are NOT your friends. They are only in it to make money.

Do yourself a favor and pay cash for a car that you can actually afford.

Buying a brand-new car is one of the biggest money mistakes I see young people making. Don’t let that be you!

-Megan

This post was all about the meaning behind 0% APR car loan deals and why you should NEVER get one!