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The 0% Financing Craze: A Good Deal?

At the moment, more than a third of the new cars for sale in the United States can be purchased with zero-percent financing offered through car manufacturers. Toyota, Nissan, Ford, Infiniti, Mercury, Chrysler, Mazda, Lincoln...the list of automakers offering interest-free financing deals just keeps growing. Commercials touting the offers with annoying songs and shouting announcers have taken over television and radio -- and the craze has probably just begun.

The most aggressive auto incentives of the year traditionally appear just after Thanksgiving weekend. With 2008 shaping up to be the worst year for auto sales in perhaps two decades, we expect that the number of these offers will actually increase shortly.

But do these offers make any sense for car shoppers?

Up to a point, they do. But some buyers might be better off exploring other options.

Credit Concerns

The deals are typically limited to buyers with very good credit, in a time when many Americans have seen their credit ratings battered by slow economic conditions. 

Dealers are reluctant to say exactly what the cut-off point for the offers is -- they don't want to scare away a potential customer on the phone. But three Toyota dealerships we called shared with us that buyers need at least a 650 FICO score to qualify for that brand's highly-touted zero-percent financing offers. Two Ford dealerships told us 700 was their minimum, while a third said 750. 

Knowing your own score is one of the first steps to negotiating a good car deal. But keep in mind that in 2007, the average American FICO score was 678 -- and that was in better economic times when more people were able to easily make payments. Automakers are competing for a dwindling pool of buyers with good credit, and they're wary of buyers with anything else. These financing deals aren't available to a fairly large portion of the population.

High Monthly Payments

Assuming your credit is in shape, another key consideration is how much money a car will take out of your monthly budget. This is another area where interest-free financing loses some of its luster.

Let's say, for example, you're interested in a 2009 Mazda6 iTouring model with the Convenience Package and a moonroof. The vehicle has an MSRP of $25,745, but you've talked the dealer down to $24,000, and you have $3,000 available to pay down.

You can accept Mazda's interest-free loan offer for 36 months, and pay $583.33 per month.

Or you can accept Mazda's other current offer on the car: 3.9 percent financing for 60 months.  With that deal, you'll pay $378.18 per month.

The low monthly payment is enticing and might help some Americans stay within their budgets. The U.S. Department of Transportation says that most Americans now keep a car just over seven years -- so even under the longer-term loan, you'll probably pay off the car before you give it up.

But be clear on what you're paying in the long run. Over the life of the loan, you'd pay $1,691 more in interest than with the interest-free loan. And you'll eliminate the car payment from your monthly expenses two years later than you would with the zero percent offer.

Forgoing Rebate Offers

With many of today's offers, buyers have a choice: Accept zero-percent financing, or a cash-back rebate that can outweigh the benefits of interest-free financing. 

Let's say, for example, you're looking to put down $2,000 on a $33,315 loaded 2008 Chrysler 300 Limited. You could go with Chrysler's offer of zero-percent financing over 36 months and pay $33,315 by the time you're done paying for the car.

Or you could accept Chrysler's $5,000 cash back offer instead, then apply that money toward a $7,000 down payment on the car, financed at a 6.9 percent rate (that national average for car loans last year) for the same 36 months through a bank or credit union outside the dealership.  You'd pay a total of $2,716 in interest on the car over the life of that loan -- and minus the dealer's $5,000, you'd have parted with $31,031 of your own money over three years -- $2,284 less than with the zero-percent deal.

The rebate, then, makes sense but only if it's as high as Chrysler's. We ran the same scenario with several Toyota, Mazda and Nissan offers that have rebates in the $2000 to $3,000 range, and the zero-percent deal often came out on top. We had to work for quite a while to find the example of the 300, where the rebate is large enough to outweigh the financing offer.

Read the Fine Print

By now, you've figured out the catch. These examples use prices near MSRP for each car, and in today's market, a savvy negotiator can knock prices down significantly, right? 

That raises another concern. Having dealer financing as your only financing option can knock your ability to negotiate off-kilter. Even if you're interested in the dealer's financing deal, make sure you negotiate the vehicle price first, before you even start talking about financing. It also helps to have a financing offer from a bank or credit union.  In today's automotive market, with sales so slow that several of the world's largest automakers are teetering on bankruptcy, it may be possible to significantly negotiate down the price of the car in the first place -- and you'll be more successful at that if you walk in the door the first time with outside financing in hand.

If you're still tempted, we'll offer one final word of caution on interest-free financing: Read the contract carefully before you sign it. Many of the offers say that if you are late with a single payment, the rate increases. You could find yourself locked into a high-interest loan if you're not careful.

The catchy jingles don't change the basics of buying a car: Know your credit score, secure financing first, and go home and sleep on it before you sign anything. In fact, go home and do the math. You may well realize that the dealer's zero-percent offer just doesn't beat what you can do at the bank yourself, with the dealer's cash rebate as a downpayment.