How Do Banks Make Money on 0% Interest on Car Loans?

Technically, banks do not offer zero percent financing. In fact, the low rate is usually an incentive offered by the manufacturer in lieu of rebates, or money off the vehicle's MSRP (manufacturer's suggested retail price). The cash discount you could have received goes to the lender to buy down the rate instead. Small used-car lots also use the buy-here/pay-here technique and zero percent loans to attract buyers.

Even though it's a game played with numbers, the result is the same – you get a loan with a total payoff amount that's similar to having no interest on the loan. Reviewing some facts about zero-interest car loans (and other low-APR car loans) will help you make sure you get the best deal for your situation.

The amount a bank might make in profit for a vehicle purchase depends on the borrower's credit and the overall cost of the loan. Zero-percent financing is usually offered for a particular model and price to a borrower with good-to-excellent credit as a requirement. In order to achieve zero percent financing, the manufacturer of the new vehicle pays the cost of interest charges to the lending bank. The bank is usually a preferred new-car lender, or the manufacturer's bank, so some rate of discount for the manufacturer exists.

Zero-percent financing is offered in lieu of cash back, or rebates. Often, the rebate savings and the cost to buy down the rate from the bank are the same. To fully gauge the overall cost of a loan and how much it may cost the manufacturer to buy down the rate, use an auto loan calculator, such as the one offered by Edmunds.com.

Input your vehicle's selling price along with a standard rate to determine the amount paid back over the loan term. It is likely that the optional rebate offers the same discount. You can improve your chances for getting the best interest rate by pulling your credit reports and making sure you correct any errors on them. Visit AnnualCreditReport.com to learn how to get your three credit reports free.

Dealers make the most profit when the manufacturer offers zero percent or rebates. Manufacturers reimburse dealerships for any rebates or rate incentives. Many customers choose the rebate or zero percent instead of negotiating vehicle pricing. If a customer does not negotiate with the dealer to reduce the car's selling price, the dealer makes full profit on the vehicle's sale. The same goes for rebate discounts. Zero-percent offers also increase business for dealerships.

Smaller dealers do not commonly offer zero-percent financing. The ones that do must have enough profit in a vehicle's price to cover the cost of buying down the rate. Buy-here, pay-here lots extend their own financing. Check the value of the vehicle before you purchase it; prices are likely marked up.

Buy-here, pay-here lots that offer zero-percent financing increase their profits with fees and other techniques, explains Drive Time.com. Vehicles at this type of lot are cheaper, so the dealer likely requires that you provide half of the vehicle's price as a down payment, instead of giving you 100 percent financing. Because prices are not competitive at a buy-here, pay-here lot because of buyer credit issues, the dealer needs to make a bigger profit from its zero-percent offer.