What is an interest free car loan?

Car loans with 0% interest are most often offered by car dealers and manufacturers as a promotional offer. Sometimes these offers are for 1% interest or a similarly low rate, and may come with other incentives, like capped price servicing or luxury extras for your car.

An interest-free car loan is where you borrow money to buy a car, and only repay the principal amount you borrowed, without interest charges. If carefully managed, a no-interest loan could potentially help you save money as you won’t need to budget as much for repayments when paying off your car.  

However, there are also several potential risks to be aware of before signing up of a 0% interest car loan, such as:

• Higher purchase price: It may be harder to negotiate a discount if you’ll be paying with interest-free finance. Similarly, you may not get as much value when trading in your car.
• Balloon payment: Similarly to a novated lease, 0% interest finance could have a sting in its tail in the form of a “balloon”, where part of the loan principal is kept in reserve. By only repaying part of the principal amount during the loan term, you can lower the cost of your repayments during this time. But at the end of the term, you’ll need to repay the balloon in a lump sum at the end of the term, refinance the balloon, or sell the car.
• Less flexibility: With a no-interest car loan, you may not be offered the option to make extra repayments, to redraw previous extra payments, or to pay off the loan early. You also may not be able to select your own term length, which could affect your repayments.
• Upfront deposit: You may need to pay an upfront deposit to apply for a no interest car loan, whereas a deposit is typically not required for a standard car loan.
• Needs good credit: You may only be eligible for a no-interest car loan if you have an excellent history of borrowing and repaying money.
• Fees: Even if you aren’t charged interest, you may be charged upfront and ongoing fees on one of these car loans, which you’ll need to budget for. 

Dealer or manufacturer finance can be useful when car shopping, depending on your needs and your financial circumstances. But it’s often worth also comparing some alternative options to see what else may be worth consideration.

This could include:

• Secured car loans: Using the car you’re buying as collateral, these loans often have lower interest rates than unsecured options. Of course, you could lose the car if you don’t keep up with your repayments.
• Unsecured car loans: These personal loans don’t use your car as security, so you won’t be at risk of losing the car if you default. However, the interest rate is likely to be higher.  
• Novated lease: You may be able to enter into an agreement with your employer to lease a car using money from your pre-tax income as a salary sacrifice, which could also offer some tax benefits.
• Chattel mortgage: If you’re buying a car to use for work, a chattel mortgage is a specialist type of secured car loan for business use.