Car buyers can be faced with improbable advertisements and enticing deals every day of the week. Though only a small portion of the population is in the hunt for a new car at any given time, terms such as "zero percent financing" and "cash back allowances" seep into the general consciousness, and consumers look for those deals when they go car shopping. The question is which of these terms--if either--really means anything to the average shopper.
Zero Percent Financing
Almost every loan comes with interest. Interest is the bank's way of making money from lending people funds. It means that customers are going to be paying more than the cost of the item (in this case, a car), as they'll be paying back interest in addition to the principal. Zero percent financing simply means the finance company has agreed to give out car loans without charging a dime in interest. This could be for only a specified period (such as zero percent financing for six months--which means the customer has six months to pay only on the principal), or it could be for the entire life of the loan.
Zero Percent Financing Benefits
Zero percent financing is a big draw for car lots looking to hold a sale. Compared to loans found in the credit card industry, car loans typically have favorable APR rates to begin with. But to take it down to zero means the car buyer has only to worry about the principal when paying off the car--or at least until the initial promotional period is over.
Zero Percent Financing Drawbacks
For those individuals who have impeccable records when it comes to paying their monthly bills on time, zero percent financing can make a lot of sense. Unfortunately, no one is perfect. A missed payment or even a late payment can result in the zero percent terms being taken away and a rather steep APR rate being applied to the loan. This can be disastrous for someone budgeting for only a certain amount per month.
Cash Back Financing
"Cash Back" deals are a favorite of car dealerships because it doesn't come out of their pocket. Manufacturers offer these rebates, so the dealership is reimbursed no matter what. Cash back is very simple for the customer--pay $18,000 for the car, accept the $1,500 cash back rebate, and there you have it. Instead of paying $18,000, the customer pays $16,500.
Cash Back Benefits
If a car buyer walks onto a dealer's lot with cash in hand, cash back deals are usually preferable to anything on the financing side. These people are looking to avoid a monthly payment and simply get the transaction over and done with in a single stroke. Cash back is simply icing on the cake. Cash back from a car dealer can make sense for those looking for a loan, too, especially if they know they can get better terms on a loan through a third party.
Cash Back Drawbacks
Cash back may not be the way to go if third-party financing can't beat the zero percent offered by the dealership. This sounds like a no-brainer (how can a finance company do better than zero percent?). But you have to look at the whole picture.
Zero percent on the entire cost of the car may still be a worse deal than a good cash back program combined with a low APR financing loan from a third party. Another drawback to paying cash up front is that the money could be better used for investment in the meantime. Giving it all to the car company may avoid a costly loan, but it doesn't do anything to make the money work for you, especially when considering what a poor investment a new car is in the first place.
Considerations
Consumers have to be aware of bait and switch techniques commonly used by car lots to bring customers into the showroom. Often, the best financing rates, including zero percent, are only available on a select number of cars. They are there as a sort of loss leader, intended to lure shoppers into the hands of a competent salesman who can direct their attention to another deal.
In any case, customers should be careful to do the math on any purchase choice. Check with third-party finance companies and compare rates with what the dealership is offering. Don't allow limited time promotional periods (such as zero percent financing for the first six months) to sway your judgment.
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