Zero percent APR and deferred payments can be dangerous
In light of the economic impact of the coronavirus and the general desperation of automakers to sell cars, several brands are offering special financing programs such as zero interest loans and/or deferred payment programs. Kia’s version is a good example of how these programs can be both possibly good business and financially dangerous.
This story was originally published on April 28, 2020
KIA offers up to 120 days of deferred payments and up to 75 months at zero percent APR on specific models such as 2020 Optima (Hybrid and PHEV), 2020 Sorento, 2019 Niro (EV and PHEV), Cadenza, Stinger and K900 . Other models have zero percent financing for up to 66 months.
The key fine print in the ad states the following: “The postponement of the payment schedule is optional and will extend the duration of your contract”. Clearly you don’t have to defer your payments if you don’t want to, but if you do and you were to finance a car for 75 months, that would mean your total loan would be 79 months, or about six months and -a year and a half.
It’s financially risky on several fronts. First of all, long loan terms obviously mean it will take a lot longer to pay off the balance, but it also means that the rate of depreciation of your car could be faster than you pay off your loan, which increases your risk of being underwater. The deferred payment plan exacerbates this risk because most cars experience the most dramatic depreciation in the first year. So in this case, your brand new Kia is rapidly losing value, but no payments are made for the first four months to reduce the principal loan balance.
Let’s look at the Optima SX, which has an MSRP of around $32,000. One-year-old examples with reasonable miles run around $21,000 to $23,000. This probably means that the trade values of these were between $18,000 and $21,000. This Optima loses about $12,000 in value in one year.
In all honesty, buyers probably aren’t paying the list price for a new Optima. But even if you got a price of $28,000 on a $32,000 car, depending on your local tax rate, your transaction price is probably closer to or above $30,000, so you’re still looking at a lower price. at least $10,000 between the total cost and the residual in the first year.
Now suppose a buyer finances this Optima at $30,000 including all taxes and fees and makes 75 months at 0% and deferred payments for the first four months. Their payments would be $400 per month. But in that first year, they would have only paid $3,200 for principal, while the value dropped by at least $10,000. Even in the second year, with a total of 20 months of payments, the buyer only paid the car back $8,000 and it continued to depreciate.
Obviously, this risk of depreciation with deferred payments and a super long loan can be mitigated by a substantial down payment which would establish some equity in the car and keep buyers ahead of the curve regarding the loan balance of the car by relative to the value of the car. However, many buyers often finance 100% of the purchase or, even worse, convert negative equity into a new car loan.
I have covered before this the most an expensive car buying mistake can be buying a car and trading it in too soon, but these long-term loan programs combined with deferred payment programs further increase the risk.
There’s nothing wrong with taking out an interest-free loan, and deferred payments can give some buyers some breathing room if their current income situation has taken a hit. But remember that just because something looks like a good solution doesn’t mean it is.