Why a Zero Percent Auto Loan Isn’t Always the Best Choice

Brian writes in:

I was at a local car dealership looking for a replacement for my truck. I only have about $8000 in savings so I knew I would have to take on some debt to buy. The dealer offered to sell me a new F150 for a good price and a zero percent auto loan for 36 months for $589 a month car payments. This seems awesome and I am looking for any problems with it.

Over the last few months, I’ve received a few emails like Brian’s, where individuals were strongly enticed by 0% or other extreme low interest loans. Are they a good deal? Should they sign up for these loans before making a purchase?

The problem with such loans is that they don’t eliminate what I consider to be the chief problem with all debt. Yes, they have spectacular interest rates and, yes, they’re often sold as being “free money.”

However, all debt – including 0% debt – has a strong negative impact on your future cash flow. By signing up for this debt, Brian, you’re agreeing to pay $589 monthly for an auto loan for the next thirty six months.

That means, for each of the next thirty six months, you’re going to have to come up with $589. It doesn’t matter whether money is tight that month. It doesn’t matter whether you have a job or not. None of that matters. Come up with the $589 per month or they’ll repossess your truck. Add on top of that the vehicle registration costs, the insurance costs, and the maintenance costs and you’re marking off at least $700 a month for this new vehicle each month.

That’s a pretty big responsibility to throw onto your future self. For the next three years, you’re making a commitment to $700 a month without knowing what the future may hold.

Does your future hold steady employment – or is a pink slip around the corner? Will your health be perfect in three years? In three years, will you find yourself in a situation where an F-150 doesn’t meet your needs?

Even if everything goes perfectly, there will still be months when $700 from your monthly budget will really hurt in the form of missed opportunities. Some will simply jump on board those opportunities anyway in the form of credit card debt, further mortgaging their future self.

If I’ve learned anything over the years, it’s that relying on your “future self” to do things you want right now is a quick route to failure. Our future selves are unreliable for the reasons I listed above: job loss, change of heart, illness, life changes, and so on.

Debt is always a challenging choice because it relies on that inherently unreliable “future self” to pay it off. The fewer commitments you put on your future self – and the more commitments you just take care of today – the easier you’ll find your life getting as time goes on. That means more freedom in the future, not less. That means a greater ability to go in whatever direction life leads you, not less.

I won’t say explicitly that a debt-free lifestyle is the best choice. There are times where debt is the preferred option or the only option. For example, if you’re living in a situation where the cost of renting housing is comparable to that of taking out a mortgage to purchase a home, the purchase may be the better choice.

In most situations, though, debt merely allows you to put big burdens on your future self in exchange for something you don’t need today. Brian, do you really need the shiny new 2011 F-150? Or would a used model work for now, putting less of a burden on your future self, while you save up the cash for the vehicle you really want down the road?

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  1. triLcat says:

    I live in Israel, and I keep seeing people who are talking about replacing trucks, big cars, a mom with one kid buying a camry, etc.

    It looks like people simply buy TOO MUCH CAR in the USA. In Israel, if you have three kids or less and you’re not making money hand-over-fist, you buy the Corolla. My parents have a Corolla, and we have 2 car seats in the back most of the time. I can get my double-stroller and a whole bunch of groceries in the back too. (I don’t have a car, so my parents help out sometimes).

    My husband and I live without a car. A lot of my friends live with only one. The only people I know who have minivans or vans have 4 kids or more.

    Get a roofrack for cargo or rent a trailer for the once in a blue moon that you need to move something. If you have 2 kids, you don’t need a minivan!

    Think about your wallets, people!

  2. Jessica says:

    I have the same questions as Trent. Is this truck going to be used for toting stuff around? If so, you are probably better off getting an older model. Whatever you decide make sure you get a lot of use out of this truck.

  3. valleycat1 says:

    Exactly. Do you just like driving a truck, or is the truck bed something you have to have for your work? Years ago when my husband (a farmer, who has to tote equipment & chemicals almost daily) had to get a replacement truck, he found a used one for $9000 & drove it for 10 years – trucks are by design real work horses, so used ones generally area good deal, especially since most aren’t initially used as work horses.

    Whether you need a truck or could use a car, $8000 would buy a pretty decent vehicle. And then you could practice saving the equivalent of that car payment every month – & end up with enough for a new vehicle in a couple of years.

  4. JN says:

    Well said – brother… well said!!! Thank you for putting this into words…. I’m getting ready to teach a few young soldiers about major purchases and you have summed it up precisely!!!

  5. Johanna says:

    Unless you have enough money in the bank right now to meet all your expenses for the rest of your life, you need to rely on your future self to pay for stuff. Even then, there’s the risk that your expenses could be higher than you’d planned, or inflation could eat away the buying power of your savings. If you’re looking for a perfectly risk-free life, you’re not going to find it. Instead, you need to balance risk (possibly not being able to pay for the new truck) against reward (having a new truck).

    Telling Brian that he shouldn’t want a new truck is not helpful. Instead I’d encourage him to think about whether he wants the new truck *enough* to take on the additional cost and the additional risk. I’d also encourage him to look carefully at how the $589 car payment would fit into his monthly budget. If he really has an extra $589/month to play with, it seems to me that he would have built up more than $8000 in savings by now, but only Brian knows for sure what his situation is.

  6. Amanda says:

    Is spending 8000 going to make him have no emergency fund?

    Trilcat-people have different needs. My husband and I have no children but frequently have passengers. Sometimes 6 or more. We have an 8 seat suv. In us with team sports or playdates a familys van may be full a lit of the time.

    Congrats to you for being able to live without a car and save $. I agree that most Americans have too much car; however, a blanket statement like you made may not apply to everyone. Peoples needs/wants/budget’s are all unique!

  7. tedc says:

    Great advice. Plus another possible concern- if you miss or are late on a payment, some of those “no interest” loans will make you responsible for all the interest at a default rate after a default.

  8. Laurel says:

    I too have a hard time buying into not relying on your future self…is our economy really that horrible that we should all live in fear of being laid off tomorrow?

    Yes I have never had a car payment that high, and it is a lot of money but really 0% is awesome. We financed my engagement ring, our furniture, tv, etc on 0% deals, all of which we paid off before we had to.

    I do agree that often we buy things on credit that we should not, but we just don’t know enough about Brian to really say if this is a good idea. Besides my future self *is* responsible and reliable, I’ve only gotten more responsible as I’ve gotten older so I have no reason to believe I’d suddenly hit an age and think “hmmm I want to be a kid”

  9. just me says:

    Nothing is free. 0% loan means the interest amount is tacked onto the base cost of the truck.

  10. Martin says:

    I have to say I agree with Johanna’s comments – if you had a free $589-$700 a month, wouldn’t you have more than $8k saved?
    Brian – I think you should really evaluate what you want/need out of a vehicle. A lot of people WANT a truck (myself included) because they like the driving position, the ability to haul, and they’re just cool vehicles. The problem is, that they get maybe 15mpg, they’re a pain to park, and unless you go with one of the extended cab models, they’re small inside.
    You didn’t mention why you were replacing your current vehicle. If it’s still in good working condition, how about keeping it and putting the $600ish a month into a “car fund”?
    That way, when you have enough money for a new truck/car or your current truck is completely dead – you’ll have a special reserve fund to pay for a new one. (and if you can’t save the $600/month you’ll know you can’t afford the new truck)
    Hope that helps!
    Martin

  11. Gretchen says:

    One would assume you would be paying less maintance, and you are already paying insurance.

    So it’s not really rounded up to $700.
    Also, maybe this is the truck he really wants/needs.

    All other things being equal, I would certainly take the 36 month 0% over the 60 month 4 percent (or whatever. )

  12. J.O. says:

    I thought Trent’s point was simply that since we don’t know – and CAN’T know – what the future holds, it puts us in a better position if we have as little debt as possible.

    He didn’t say that you needed to have enough money in the bank for all your future needs; he said it’s unwise to assume you’ll have your current income and health for the duration of the debt if you can meet your requirements with your current assets instead.

    He didn’t say that your future life would be without any risk; he said you should strive to reduce the risk as much as you can.

    He didn’t say that your future self is unreliable due to “acting like a child”; he said your future self is unreliable because your job or health could fail.

  13. Kenny says:

    An idea I’ll add: If purchasing on financing try to make enough of a down-payment that the vehicle will worth at least the remainder on the loan for the years to come. That way if life changes and you have to sell at least it doesn’t cost you money.

    Also on low interest financing the dealer’s not going to lose money. If it’s not in the rate it’s in the cost somewhere else.

  14. Mary Kate says:

    Another great post Trent. It seems like a big obligation to me, to commit to paying that much every month for something that depreciates the minute you buy it. I’m not against people buying new vehicles if they wnat them, but I think Trent wrote an excellent post about some considerations Brian might want to make.

  15. BeccaT says:

    In regards to the car purchase, I’ll betcha that a different dealer with higher interest loans would charge less for the same car. With all car purchases, whether new or used, you have to look at the total cost of annual ownership, including the higher cost of repairs to a used car. If you can buy without needing a loan, a new can can be a better deal, or at least be about the same. But I agree with Trent that if you have to take out a loan, it is probably wiser to buy used. It all depends on the car.

    As for not knowing what the future holds, I agree even when you think you have all bases covered, life can throw you a major curve ball. A married friend just learned his group rate for health insurance is going up from $110 a week to $190 a week. He was given about two weeks notice, as the rate increase goes into affect in October. I have seen the paperwork, this is right. This is for a family plan with low deductible. They can switch to a high deductible, for the same as they were previously paying, but if they accidentally get pregnant they’re in trouble. Besides, they had been going to try for a second child this year. This is a young couple that is already doing everything right, thrift-wise. There is no room in their budget for this extra $80 a week, at least in the short term.

    I’m intentionally changing the curve-ball topic from cars to health insurance, because I wondered if anyone else out there has seen a similar increase. I am curious if this is a unique situation, or if we all are on the cusp of major increases.

  16. Kate says:

    Perhaps it should have been better to focus on how much the total cost of the car is instead of how much it will be per month. Dealers focus on the monthly payment to keep the consumer from recognizing how much they have jacked up the total price. They get their money one way or another.

  17. triLcat says:

    Amanda – and if you had a 5-seater, your social life would change drastically? I’m guessing at least one of the multitude of people who are usually in your van has a car. You’d get one of them to put their car into the pool and life would go on.

    How we manage without a car is … well, it’s getting to the point that we can’t/shouldn’t. It’s impeding my ability to start a business, my husband’s ability to make extra money, our ability to do a lot of things, but with two kids, a dog, and the likelihood that it would become the storage shed for much of two businesses, we’d still probably choose a corolla or focus over a camry or taurus.

    Yes, it’ll mean that we can’t carpool, because three car seats won’t fit across the back of one of those cars, but I’d rather give up carpooling than pay a lot more for a bigger car.

  18. Honey says:

    This is why my boyfriend and I never plan to buy a house. How do we know our future selves won’t lose a job and need a smaller place, or move to a new city at a month’s notice? Waaay too problematic to tie ourselves to the same residence for more than a year at a time (and we’re month to month right now)…

  19. CNM says:

    Read the fine print of the terms of a 0% loan. What will the interest rate be after the 36 months? What are the penalties for early payment? Sometimes these 0% loans look so great at the outset but then turn into pretty crappy loans rate-wise after the initial honeymoon period. Also, from my perspective, $580-some per month is a lot of money for a vehicle. $8000 is also a lot of money. I would think that you could get a good quality used vehicle for close to that amount.

  20. Josh says:

    Seriously debt kills. It’s really hard because we are all so easily enticed by things we want, especially when you find a good deal. But it’s hard to always remember that if you can’t afford it, don’t buy it…period. And if you don’t need it you should also seriously consider what you are doing.

  21. Mike says:

    I agree Trent. Debt obligations create costly entanglements that should be avoided whenever possible. Be free. I notice when I’m driving that the hot cars of 5 years ago don’t seem so special today.
    I’m doing a series on mortgage debt at http://proborrower.wordpress.com/

  22. Rachel says:

    Trent, on all of the commercials that have 0% offers, the fine print says something like “For every $1,000 financed, the person who takes the loan will pay $XXXX in fees. Doesn’t this erase any sort of benefit Brian might get from the 0% financing? Read the fine print!

  23. getagrip says:

    “I only have about $8000 in savings so I knew I would have to take on some debt to buy.”

    Some debt to buy? This guy is taking on $21,096, or more than 2 and half times what he’s planning on putting down. That isn’t “some debt”, that’s mostly debt!

    I’ve got nothing against buying new, just don’t act like 0% is such a great deal.

    Here is an example of how you can lose in 0% financing even with the same amount of money if you choose 0% over the rebate:

    36-Month Car Loan Comparison
    APR 0% 3.99%
    Cost of car $20,000 $20,000
    Less equity $4,000 $4,000
    in trade
    Less rebate $0 $2,000
    Amount to finance $16,000 $14,000
    Monthly payment $444.44 $413.27
    Total cost $16,000 $14,877.85
    Savings $0 $1,122.15
    Source: Capital One Auto Finance

    As always, run the numbers before you go in!

  24. getagrip says:

    Sorry, That comparison got gummed up when I did it side by side. Here they are stacked instead, hope this is clearer:

    36-Month Car Loan Comparison
    APR: 3.99%
    Cost of car: $20,000
    Less equity
    in trade: $4,000
    Less rebate: $2,000
    Amount to finance: $14,000
    Monthly payment: $413.27
    Total cost: $14,877.85

    36-Month Car Loan Comparison
    APR: 0%
    Cost of car: $20,000
    Less equity
    in trade: $4,000
    Less rebate: $0
    Amount to finance: $16,000
    Monthly payment: $444.44
    Total cost: $16,000

    So you potentially save $1122.15 not taking the 0% offer.
    Source: Capital One Auto Finance

  25. Marsha says:

    It wasn’t clear to me whether he was going to have to put $8000 down AND make the $589/month payments. That would be a very expensive truck.

    It’s a lot more viable if he was going to be able to finance the entire cost of the truck at 0% and hang on to his savings. There’s too many unknown factors to know whether this would be a good idea, but at least if money got tight for a few months, he’d be able to make his payments out of his savings.

  26. Jeroen says:

    The absolute best thing is to take the 0% loan while having the money for the car in your account. This way you win twice: you get interest on your money AND the real value of your payments goes down (assuming inflation)

    Win-win for having the cash in the bank.

  27. deRuiter says:

    Dealers charge more for a car / truck if they give a 0% loan. Walk in with cash and generally you can cut the price because the dealer doesn’t have to wait the length of the loan to collect the extra amount you were charged for the vehicle. $8,000. will buy a pretty decent work truck. If you can’t pay cash you may not need a fancy new truck.

  28. Kevin says:

    @BeccaT:

    “Besides, they had been going to try for a second child this year. This is a young couple that is already doing everything right, thrift-wise. There is no room in their budget for this extra $80 a week, at least in the short term.”

    If money is so tight that an extra $80/week would break their budget, maybe they should hold off on spawning more mouths to feed, hmm? Just a thought.

  29. Courtney20 says:

    You are probably sick of people bringing this up, but I have trouble putting credibility in any car purchasing post you write, since you committed your ‘future self’ to monthly car payments for your Prius, and you didn’t even get 0% financing!

    That said, $589/month is a ridiculous amount to pay for a car payment. You could finance 2-3 cars for that amount.

  30. Trent Hamm Trent says:

    “You are probably sick of people bringing this up, but I have trouble putting credibility in any car purchasing post you write, since you committed your ‘future self’ to monthly car payments for your Prius, and you didn’t even get 0% financing!”

    Interesting, considering I’m looking at the Prius title right now.

  31. Louise says:

    I took a 0% financing 4 years ago,June 2006. It worked out well for me. I had the money in my portfolio,to pay for a new truck. But….

    I asked about 0% which was being offered on the old model, 2006, not the new model, 2007, I wanted.

    (I want to add my mother is a retired Ford employee, so I was going to use her discount.I never tell the dealership I will be using it until I have already done the talking.)

    At first they balked at 0% on the 2007. I said no deal. They came back with 0% if I would pay in 3 years. I still hadn’t told them I intended to pay cash and use my mother’s discount.

    Yes, I needed a new pickup, Ford Explorer Trac, with 4 wheel drive, and some other goodies. I am a widow and live in the country back in the timber in NW MO. The 1992 truck I had was a worry to me. Besides being old it didn’t have 4 wheel drive.

    The payments per month were $700. But my children a grown and gone and I am retired. Yes, some months the $700 made it tight month for me. I usually sent extra money each month, but some months no. I actually paid off the 0% loan in 2 1/2 years.

    So if I can drive the 2007 for 14 years, like I did the 1992, I will be good.

    If I had a financial problem I could have always gone to my portfolio.

  32. Bob says:

    Many of the 0% loans that I’ve seen have a monthly account “service” fee of some kind. This, believe it or not, IS interest. A small monthly dollar amount, usually a function of the unpaid balance (sound like interest yet?) can result in a significant APR.

  33. Daniel says:

    @ triLcat (#1):

    My “old self” wouldn’t have agreed with you. But the “new me” does. :)

    I began driving and purchased a very large vehicle, then a couple of years later upgraded to a rather luxurious sport sedan. These cars are so expensive here in the U.S., both in terms of purchasing and maintaining.

    Recently, I purchased a subcompact and couldn’t be happier. Gas mileage is through the roof, the vehicle is extremely easy to park, and it still carries up to 5 people + cargo (though I did consider a tiny smart fortwo!).

    I hope a lot of people here in the U.S. begin to realize that a large vehicle isn’t always the way to go.

  34. Amanda Pingel says:

    Debt kills freedom

  35. Alex says:

    Given that I’m in the car market anyways, I am looking at 0% financing as a huge boon, if only because of the avoidance of financing charges as lost money.

    I guess I’m not seeing the downside of stretching a car loan out to 5 years and lowering the payments (leaving more money to invest/sock away in an emergency fund), especially when the resulting monthly payment (in my case for a new Mazda 3) is around 6% of my monthly take-home pay.

    Is my logic missing something, or am I misinterpreting your post?

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