The Puzzling Phenomenon of Interest-Rate Discounts on Auto Loans

Lloyd Cohen

The Journal of Legal Studies, 1998, vol. 27, issue 2, 483-501

Abstract: Given that an interest-rate reduction appears to give something to consumers that is worth no more, and often less, to them than it costs the manufacturer, why do automobile manufacturers offer interest-rate discounts on automobile loans as an alternative to cash rebates? The answer to this puzzle is that while interest-rate discounts offer no advantage when the borrower repays the loan, they offer a benefit to the combined interests of borrower and lender in the event of default. The interest-rate discount serves to correct the more pernicious consequences of a misguided legal rule for calculating the value of repossessed automobiles imposed by the Federal Trade Commission in 1979 In the Matter of the Ford Motor Company et al. The interest-rate discount creates a financial buffer zone for the lender in the event of repossession of the automobile that is more valuable to him than it costs the consumer. Copyright 1998 by the University of Chicago.

Date: 1998
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