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Advertisement on the television, Internet, radio and newspapers promise consumers that they can get a new car with zero down car loans. This sounds great, at first, because down payments are usually 15%-20% of the price of the car. However, there are some things to consider before jumping into zero down auto loans.
Without actually committing false advertising, the car dealer may ask the customer to make a small down payment. This is because the financing is done through a third-party bank or lender, and they require a down payment. However, car dealers have figured out ways that customers don’t have to come up with the cash to make a down payment, which is why they can boldly say, zero down car loans.
The Advantages to Zero Down Car Loans
The two main ways the dealer accomplishes this is through trade equity and vehicle rebates. Trade equity can only be used if the customer has a car to trade in. The price of the car can be put towards a down payment. If the car is not worth the entire down payment, the deal will give the amount and roll the remainder into the car loan. Even though the customer didn’t have to come up with the cash, they did have to use the value of their trade-in. When the dealer advertises that there is zero down payment required, it may be legal, and is a great pull to bring in customers, but, in this case, it isn’t actually true.
However, giving a down payment is a better way to get a car loan, and these methods provide a down payment without actually coming up with the cash. So, even though they may not be completely accurate, they have advantages.
The main advantage is they reduce the amount of the loan. This is called negative equity. A fact of nature is that a new car loses from 20% to 25% of its value practically the minute it is driven off the lot. If the zero down car loan was for the full price of the car, the customer would be paying for a loan that is 20% to 25% more than the value of the car. With a down payment, either from a trade-in, cash-back or from their wallet, the amount of the loan is more in line with the actual value of the car.
The Trap of a Zero Down Payment Car Loan
The above doesn’t seem so bad. In fact, it seems like a good deal. However, there are No Money Down Auto Loans that can cost the customer much more in the long run. Many people don’t really understand the intricacies of interest rates and their impact on a zero down payment car loan. Unfortunately, car dealers may take advantage of this ignorance, and convince the buyer that driving a car off the lot in exchange for nothing is a really good deal.
Without making a down payment, the customer may take three years just to cut the loan in half. If they make a down payment up front, the amount owed in three years can be greatly reduced and, in many cases, the loan can be completely repaid in a little more than three years. The higher the interest rate, the longer it will take to repay the loan. This is because the monthly payments are going towards the interest on the loan and not the principal. If the principal is not paid down, this can go on for years.
This is also called being Under Water. Many times, with zero down car loans, the amount the buyer owes on their car loan after paying for two or three years is more than the car is actually worth. If a down payment was given at the beginning, the buyer can often sell the vehicle for a price that will pay off the loan. In the case of zero down auto loans, this is often not the case. The car may be falling apart, but the owner can’t afford to give it up, and all the while they are still making payments on their ‘fantastic’ zero down payment car loan. If making a down payment of any kind is out of the question, a good lease agreement is far better than this kind of debt spiral.
Car buyers need to be wary about any zero down payment car loan because the finance company will always be looking to get the maximum amount of interest. The buyer needs to pay attention to the numbers and understand exactly what he or she is getting into.
The 0 Down Lender
Companies that finance auto loans consider no money down car loans riskier than loans where the buyer paid a down payment. This is because the buyer has invested money into the car and is more likely to keep up the monthly payments and, finally, repay the loan. Statistics show that buyers who choose zero down auto loans are more likely to default on the loan in the end. Default is bad enough, but the car will most likely be worth less than the amount of loan that is left.
In fact, it’s people with bad credit scores who most need 0 down auto financing, and they are the very ones who could have trouble repaying the loan. Lenders may give the loan, but the interest rate could be very high. The cost of the car will also be taken into consideration. If the price is higher than the value of the car, lenders will most likely not give the loan because if the buyer defaults, the lender is stuck with a valueless car.
There are two main ways out of this. One is to have a co-signer for the loan, and another way it to give security for the loan. This is not recommended because if the buyer defaults on the loan, they lose the security.
Car dealers need to sell cars, and they will use every means to do so. This means they attract customers with their advertising of cars with zero down payment, get them attached to a particular car or model through test drives and sales pitches, and by the time the buyer is in the office talking about payment, they realize that zero down car loans won’t work for them. The dealer is hoping that the buyer is so attached to the car that they won’t walk away. The main topic may be the size of the monthly payment and not the interest rate. Also, the credit score of the buyer plays a big part. Low interest rates are only given to people who have a high credit score. This is where the buyer gets stuck. They are attracted to the car, the zero down payment and the low monthly payments and have no idea of the serious trouble they are walking into with the interest rate. Statistics show that one out of ten buyers just go with the offer given by the dealer and their zero down auto loans being sold.
So what have we learned? Basically, putting as big a down payment on an auto loan as possible is the best option for reducing the cost of the car. In fact, any down payment is better than zero. In any case, buyers should beware and go to the dealership with at least a little understanding of interest rates and the final cost of the loan. Zero down car loans may be the biggest financial mistake you ever make.