The Zero Percentage Trap

I was recently asked whether or not a 0% auto loan was a deal worth pursuing. My answer was short and sweet: usually not… least usually not for most people. The explanation requires a bit more clarification.

From a logical standpoint, a 0% loan sounds like a homerun, right? I would certainly jump for a 0% mortgage….wouldn’t you? But, the 0% auto loan is a different animal.

Many people buy cars and trucks on emotion and without enough thought and diligence. In contrast, home purchases, require several steps and several weeks to complete. It takes about a half hour to an hour to buy a car.

Here’s the rub

When it’s time to purchase a new (or new to you) car or truck, simply purchasing based on the monthly payment is trouble in the making. The process should begin with an end result in sight. For example, research and financial judgment should lead to a few choices in make and model, as well as a target price range. Then the search should begin.

Stumbling onto a car lot and blindly looking to replace “old reliable” can lead to a salesman up-selling you into a too much car. Someone may drive onto the lot looking for a 20k car and drive off with a $45k shiny new automobile. Then we try to rationalize our purchase: I financed it with a 0% loan!

Why this hurts

It comes down to cash flow. Sure, a 0% loan is free money, but it doesn’t mean the payments are affordable or pain-free. More importantly, it encumbers future cash flow, which means future financial growth may be hindered. For example, tying up $400 extra dollars each month may mean additional retirement contributions may not be made. That’s $4800 a year in pre-tax deductions missed, which means someone in the 25% tax bracket may lose $1200 or more in tax savings. So, yes, a 0% auto loan can cost you money!

Remember, a wonderful guide post for living a wise financial life is the Five Fundamentals. The last fundamental states to have no consumer debt. A 0% auto loan is still debt. While I realize not everyone can pay cash for cars, doing it wisely is extremely important. Essentially, buying the right car for the right price is more important than financing an over- indulgence purchase with a 0% loan.

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