How To Buy A Car: Financing With A Dealership vs. A Bank Loan

This article originally appeared on the Motley Fool.

When you want to buy a car, you'll find a wide range of different incentives designed to make your purchase more attractive. One such incentive involves your dealer offering you the chance to borrow at 0% to pay for your vehicle. Financing at 0% saves you interest compared to a standard car loan, but it can be tough to figure out exactly how much. Because you can sometimes choose other incentives, such as immediate cash back rebates, it's useful to know what 0% auto financing is really worth. Below, you'll get the tools you need to put a value on low-rate borrowing incentives and make a smarter choice with your auto purchase.

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The trade-off

Typically, dealers will offer you a choice: finance your auto purchase through the dealer at 0%, or get an outside car loan from a third-party financial institution and collect a rebate incentive. Based on current offers, rebates can amount to thousands of dollars in up-front cash that you can use to put toward a down payment, allowing to borrow less money. However, you'll still have to pay interest on your outside car loan.

The question therefore becomes how much your interest savings on a 0% loan will be and how that compares to the savings from the up-front rebate. That in turn requires some shopping to find out just how good a car loan you can get. Then, you can run the numbers and get the right answer for your situation.

The calculator below takes a slightly different tack on the question. It looks at how quickly interest savings catches up to the up-front rebate amount. To use it, just put in the price you'd pay without a rebate, the amount of the rebate, and the interest rate and loan term on the outside car loan you'd have to get if you don't choose the dealer financing.

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Editor's note: The following language is provided by CalcXML, which built the calculator below.

A simple example

To see how this calculator works, let's use a basic example. Based on current offers, one car company is offering 0% financing for 60 months or a rebate of $2,500 on a car that typically sells for around $50,000. A look at prevailing interest rates for car loans shows that some banks are offering as little as 2.5% interest on a 60-month loan.

When you run those numbers through the calculator, you'll find that the loan payment is just $10 more on the 2.5% loan, and you start off paying just under $100 in interest per month. It takes 50 months for the savings on the no-interest loan to catch up to the amount of the up-front rebate. Therefore, as the calculator advises, if you intend to sell or trade in your new vehicle before hitting the 50-month mark on the loan, then it makes sense to go ahead and take the rebate and use outside financing. If you plan to hang onto it longer, then the interest-free loan is the slightly better choice.

In this scenario, the advantage of the 0% financing is relatively small. However, it assumes that you'll be able to qualify for a relatively good interest rate from a third party. That isn't always the case. If you bum the interest rate up to 5%, you'll see much greater benefits from the 0% financing, and the breakeven date for the car loan will come much sooner -- just 26 months in.

When you're in the market for a vehicle, the incentives you can get from a dealer on a car purchase are always worth checking. Depending on your particular situation, choosing wisely can save you thousands of extra dollars on your purchase over time.

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