In an effort to sell cars to debt laden consumers Toyota is now offering 84 month car loans(*). The immediate effect is to lower the monthly payments. In the long run this could have two effects.

The first long term effect is an increase in the price of new cars (relative to inventory) just like lower mortgage rates cause real estate to rise. The reason is the people finance according to their monthly purchasing power and not the total loan value.

The second long term effect is a decrease in the sales of new cars. New cars depreciate really fast. A 7 year car loan will be paid off very slowly. This means that people will be underwater (owing more than their car is worth) for a long time. Therefore the car can not be used as a trade in.

In the short term the auto makers hope to sell more cars at the same price.

(*) Some lenders like GMAC (General Motor’s financing arm) and various credit unions. are even offering 96 and 108 month loans, but these are not (yet?) very popular.

The side effect of this double whammy is that used car prices will go up as the market dries up. This will increase the consumer price inflation.

Cheap credit tends to cause a bubble. Will people never learn?

Car loans stretch to 7 years or longer

Originally posted 2008-02-16 07:47:17.