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Zero Percent Car Financing: The Hidden Cost of a Free Loan

By Heidi Unrau | Published on 20 Jul 2023

A key resting on vibrant red dice, symbolizing chance and opportunity.

    You know how it goes. You’re doom-scrolling your newsfeed when suddenly, there it is! The coveted offer boasting zero percent financing on a fancy new car. I get it, it’s hard not to feel a flutter of excitement about a free car loan, especially in our current interest rate hellscape. But before you YOLO your way down to the local dealership, hold your Tim Bits. Is it actually a great deal? Let’s unravel the enigma that is zero percent financing on car loans. 

    The importance of affordable car financing

    By land size, Canada is the second-largest country in the world. If you live here, you know that driving across a single province is the equivalent of driving across several European countries. And our weather makes for some pretty nasty travel conditions. 

    Unless you live within walking distance of essential amenities, then owning a car is a necessity – not a luxury. From urban commuters to rural residents, we rely on our cars to stay connected and access the stuff we need. 

    But as the cost of living surges, figuring out how to comfortably finance a car purchase is making most Canadians hot under the collar. Affordable car loans play a crucial role in helping us maintain our independence, mobility, and employment, as well as our ability to access the essentials, nurture relationships, and engage with our communities. 

    In a country where our total household debt is higher than our total GDP, zero percent financing on a car loan can seem like a port in the storm. We believe these deals can help us manage our expenses more effectively by eliminating the cost of credit. That can help relieve financial anxiety and make it easier for Canucks to balance our budgets. But is zero percent financing the lifeline we think it is? 

    How zero percent financing works

    A zero percent financing offer is a car loan that doesn’t require you to pay any interest charges because the interest rate is 0%. In other words, the purchase price is the exact amount you’ll pay back over the course of the loan. This means, theoretically, you could buy a $40,000 car and you’ll pay back precisely that amount by the end of the term – as long as you don’t miss any payments. Sounds like a dream come true, right?

    The upside of zero percent financing

    The undeniable benefit of zero percent financing is the potential for significant long-term savings. Especially since the average interest rate on a new car loan in Canada is roughly 8% (yikes!). If you have a fabulous credit score and can afford the monthly payments, zero percent financing could be a great deal for you, if the stars align. Let’s break it down: 

    0% vs 8% financing: crunching the numbers

    Let’s say you want to finance a $40,000 fully-loaded SUV. The dealership gives you two choices:

    1) 0% interest rate

    2) 8% interest rate

    If both loans are financed on the same 5-year term (or 60 months), it’s a no-brainer. 

    With a 0% interest rate, you’re only paying back the amount you borrowed for the car, nothing extra. So you’d pay $40,000 over 60 months, which equals $666.67 per month.

    But with an 8% interest rate, you’re not only paying back the $40,000 purchase price but also the interest charges. To calculate the monthly payment and total payback, you should use a car loan calculator.  

    Doing so, you’d find that the monthly payment for a $40,000 car loan at an 8% interest rate over 5 years would be approximately $811.06! Right off the bat, you’re paying an extra $144.39 per month. Over 5 years, the total amount repaid would be $811.06 x 60 months = $48,663.60. 

    So, with a 0% interest rate, you’d pay back $40,000 in total. But with an 8% interest rate, you’d pay back $48,663.60 in total. Therefore, in this scenario, the 0% interest rate would save you $8,663.60 over 5 years.

    By not charging interest, zero percent financing can save you thousands of dollars over the life of your car loan. Another benefit is the simplicity of the deal. You don’t have to worry about the cost of credit, and the monthly payment is quite a bit lower which frees up your budget for other things (like investing!). 

    Where to get zero percent financing on a car loan

    Three words: not your bank. Typically, zero percent financing loans are offered by dealerships and car manufacturers through their own in-house financing departments. But if they’re not making money on interest, why the heck would they give you a free loan?

    Two words: slick marketing. Zero percent financing is positioned as a promotional deal to get people in the door to purchase very specific models. It’s a strategy often employed to boost sales for vehicles that aren’t selling as well as expected.

    It’s also a clever way to unload inventory to make room for the newest models. Plus, once you’re in the door and high on that new car smell, it doesn’t really matter if you don’t qualify for zero percent financing – they’ll hustle you into a purchase by “working something out.” 

    But hey, zero interest on a less popular model doesn’t sound so bad, right? After all, you’re a frugal ninja who prefers bargains over novelty. As long as you’re saving money, a win is a win. Or is it?

    The downsides of zero percent financing

    Despite the appeal, zero percent financing is like a stuck-up prom queen who only invites the cool kids to her afterparty. A major downside is how to actually get this deal. Those who don’t make the cut feel like 0% wannabes paying lame-ass interest charges. But that’s not the only hangup. 

    Most people don’t qualify

    In order to qualify for zero percent financing, your credit score needs to be roughly 740 or higher. According to TransUnion, the average Canadian has a 650 credit score. That’s far from excellent. Too many Canadians will never qualify for zero percent financing, making it nothing more than a baited hook.   

    You don’t get to choose the car

    Not every vehicle qualifies for zero percent financing, in fact, most don’t. Dealerships limit this offer to specific models they want to sell, like the less popular or more expensive ones. That deletes your freedom of choice from the equation when it comes to buying the right car for your needs. And you probably won’t get all the features you want either. Womp, womp!

    Or the loan term

    Zero percent financing deals almost always require a shorter term, usually 3 to 4 years. That forces you into a higher monthly payment that might not comfortably align with your budget – leaving you more vulnerable to financial curveballs. 

    For perspective, car loan terms in Canada can range anywhere from 3 to 8 years, with some private lenders offering 10-year car loans (which is a terrible idea, never do this!). But the 5-year term is pretty standard and pretty reasonable. 

    The dark side of zero percent financing dealerships don’t want you to know

    The previous three downsides are like Brisk Iced Tea compared to the hot mug of garbage I’m about to serve. Zero percent financing is a steal of a deal, for some people. For the rest of us, it’s not even attainable, so it’s a moot point. But for those who qualify and want to sign on the dotted line, you need to pump the breaks. 

    They hike the price

    Commit this mantra to memory: “You date the rate, but you marry the purchase price.” Since dealerships and manufacturers make zero money on zero percent financing, they increase the purchase price to make up for it. Or the deal is only available on more expensive models with fatter profit margins. Sneaky, sneaky. There is always the option to refinance your loan at some point to get a better rate, but you can never go back and change what you paid for the car. 

    You could end up underwater

    And since dealerships often mark up the purchase price to compensate for the rate, you pay more than you should for a new car. That puts you at a higher risk of owing more on the loan than the car is actually worth, which is terrible if you need to sell the car or if it’s written off in an accident.

    You could face a nasty surprise

    Sometimes zero percent financing only applies for the first few years of the loan term. If the dealership isn’t clear about this during talks, or it’s buried in the fine print, your monthly payment could suddenly jump when you least expect it. That puts you at risk of defaulting on your car loan or other financial obligations. Goodbye good credit, hello repossession? Thank you, next.

    It distracts you from better deals

    Not only do you give up negotiating power with zero percent financing, you could miss out on substantial savings from better promotional offers and other financing options. A cash rebate offer, for example, could save you more money overall. Especially if you pair it with a loan from your own bank or credit union

    Zero percent financing vs a cash rebate

    Let’s circle back to that $40,000 fully loaded SUV with the zero percent financing offer and compare it to a cash rebate offer. Remember, one forces you into a shorter loan term and you can’t negotiate the purchase price. The other one lowers the purchase price and offers flexible terms, but you have to pay interest. Which one should you choose? 

    1. Zero percent financing on a $40,000 SUV for 3 years 


    1. A $5,000 cash rebate, but with a financing interest rate of 4.5% for five years

    Option 1: zero percent financing 

    Your monthly payment is a whopping $1,111.11 per month on a 3-year term. But, you’re not paying any interest charges. You’ll pay back exactly $40,000 and not a cent more. 

    Option 2: cash rebate 

    The $5,000 cash rebate brings the purchase price of the car down from $40,000 to $35,000. TD Bank offers special interest rates if you purchase from certain manufacturers. So let’s pretend you sniped one hell of a deal. Financed over 5 years with a 4.5% interest rate makes your monthly payment $652.51. You’ll pay back a total of $39,150.60. 

    How will you save on the total payback?

    Zero Percent Financing ($40,000) – Cash Rebate ($39,150.60) = $849.40

    Almost a thousand dollars?! By choosing the cash rebate offer and a lower purchase price, even with a 4.5% interest rate, you’d pay less over the term of the loan than with the zero percent financing option on the higher purchase price.

    PLUS, your monthly payment is significantly lower, giving you much more financial security should the unexpected happen. Better yet, if you invested the difference between the two payments, you’d come out even further ahead. Let’s take a look. 

    What to do with the savings

    The difference between the two payments is $458.60 ($1,111.11 – $652.51). If you invested that amount every month over 5 years, assuming you get the historical 7% average annual rate of return, you’d end up with $32,876! Wowza!

    Alternatives to zero percent financing

    Zero percent financing is tough to resist, but for most of us, there are usually better financing options out there. The trick is to shop within your budget and never pay the full sticker price. Saving money on your next car purchase starts way before you step foot on the lot.  

    Borrow from a bank or credit union 

    First, get pre-approved for a car loan through your own bank or credit union. They almost always offer better rates than dealership financing, especially if you’re already a loyal customer. 

    However, you might not get the best possible rate from your own financial institution, so make sure you shop around and compare loan offers. While bank rates will never be as low as 0%, when coupled with a cash rebate from the dealer or your killer negotiating skills, the overall cost could potentially be lower.

    Consider leasing a car (hear me out!) 

    Before you call me crazy, let me explain. If you don’t put very many kilometres on your vehicle each year, leasing could actually be a better option. It often comes with lower monthly payments compared to financing with a loan. You won’t own the car at the end of the lease, but the cost savings could be more than worth it. 

    A fantastic book by Jorge Diaz explains how leasing is actually better for most people. I know, it sounds nuts but he has the receipts. Before you pull the trigger on a car purchase, you should first read Car Leasing Done Right: A Canadian Guide for Understanding & Optimizing Vehicle Leasing Costs. It could save you a ton of money and stress. 

    [Offer productType=”OtherProduct” api_id=”64e75dfa2bb7ed64e70ab296″ id=”194424″]

    Common zero percent financing traps & red flags avoid

    Whether it’s zero percent financing or some other sexy incentive, it’s critical to be on the lookout for potential traps and red flags during the car buying process. The more informed you are, the easier it is to avoid a big mistake disguised as “big” savings. 

    Aggressive sales tactics

    Some car dealerships might resort to aggressive sales tactics to push zero percent financing deals or other ulterior motives. Salespeople might pressure you into making a quick decision so you don’t have time to crunch the numbers and explore your options. Be strong and resist these tactics. It’s important to take your time to understand the deal completely and exactly how much it will cost you before making a decision.

    Buying a more expensive car

    A zero percent financing deal might tempt you into purchasing a more expensive car than you had originally planned. A free loan makes pricier models seem affordable, causing you to get excited and bite off more than you can chew. Plus, a more expensive car usually means higher car insurance premiums as well as higher maintenance and repair costs. It all adds up!

    Hidden fees & charges

    Watch out for hidden fees and charges that might not be included in the advertised price. These could be anything from documentation fees, dealer prep fees, delivery charges, or even charges for optional add-ons. Always ask for a line-by-line breakdown of all the costs associated with the deal to ensure you know exactly what you’re paying for. 

    Some fees are negotiable while others are not. And add-ons like VIN etching, rustproofing, and scotch guard are a total waste of money. Sometimes dealerships make those upgrades to the car in advance, then factor them into the sticker price! So make sure you ask exactly why the car is priced the way it is. 

    Lack of transparency

    Transparency is key in any financial deal. After all, it’s your credit score and quality of life on the line. If the dealership is not clear about the terms of the offer or if they are reluctant to answer your questions, consider it a red flag and walk your fine self out the door. A reputable dealer should be willing and able to explain all aspects of the financing offer and provide all the information in writing.

    A note about interest rates

    At the time of writing, zero percent financing offers are hard to come by. Almost no dealerships are offering this promo thanks to the Bank of Canada’s rate hike warpath. Also, the average rate on a new car loan in Canada is significantly higher than it has been for many years. The figures used in this article are for illustrative purposes only, as interest rates and car prices change regularly. It’s crucial that you examine your own situation, crunch the numbers, and compare all your available options prior to making any financial decisions. 

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    Heidi Unrau is a senior finance journalist at Hardbacon. She studied Economics at the University of Winnipeg, where she fell in love with all-things-finance. At 25, she kicked-off her financial career in retail banking as a teller. She quickly progressed to become a Credit Analyst and then Private Lender. This hands-on industry experience uniquely positions her to provide expert insight on loans, credit scores, credit cards, debt, and banking services. She has been featured in publications such as WealthRocket, Scary Mommy, Credello, and Plooto. When she's not chasing after her two little boys, you'll find her hiding in the car listening to the Freakonomics podcast, or binge-watching financial crime documentaries with a bowl of ice cream. Fun Fact: Heidi has lived in five different provinces across Canada and her blood type is coffee.