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US rate rise may not alter zero-interest car loans

By Poornima Gupta

DETROIT, June 18 (Reuters) - U.S. interest rates may be about to go up, but don't expect interest-free car loans to go away, even though it will cost Detroit's Big Three millions of dollars to keep offering them.

Zero-percent financing, which has hooked consumers for almost three years and is credited by some analysts with keeping the economy afloat during the lackluster U.S. recovery, is a costly incentive.

Automakers currently take a hit of $3,000 to $4,000 per vehicle on average to offer zero-percent loans that have a five-year payback term, said Paul Ballew, head of market and industry analysis at General Motors Corp.

"It will cost the industry some money if (interest rates) run up a hundred basis points ... it would certainly be in the millions of dollars," said Ballew, adding zero-percent loans are likely to continue for the rest of the year. "It's not as painful as people assume."

U.S. Federal Reserve officials are expected to nudge overnight rates up from their current low of 1 percent -- a low last seen in 1958 -- when they meet June 29-30 as a first step in a protracted rate rise cycle.

Though General Motors played down the effect of a rise in short-term interest rates, analysts said the auto industry is already considering other ideas -- and a possible escalation of Detroit's profit-eroding price war -- to support new car and truck sales.

GM will try to reduce its dependence on the interest-free loans by introducing deals such as "flexible ownership," where a buyer would get to use a sport utility vehicle for one weekend a year with the purchase of a sedan, said Prudential Equity Group analyst Michael Bruynesteyn in a research note.

Low interest rates helped automakers continue the cheap loan program first unveiled by GM a week after the Sept. 11 attacks in its "Keep America Rolling" campaign. Ford Motor Co. and DaimlerChrysler AG's Chrysler division quickly followed GM's lead.

FOLLOW THE LEADER

The costs will increase as rates rise, with an accompanying rise in automakers' borrowing costs putting a further damper on profit. But the incentive program and other offers are required to fuel sales, analysts said.

"They are going to have to do whatever is necessary to drive the volume," said Mike Jackson, manager of North American vehicle forecast at CSM Worldwide.

Ford and Chrysler, which battle GM in the fiercely competitive auto market, are likely to follow the lead of the world's largest automaker once again.

"They make the market and they probably will decide what to do with it," said Joe Eberhardt, Chrysler's executive vice president for global sales and marketing.

Detroit's automakers are also counting on the strengthening economy that typically accompanies an interest-rate rise to offset the higher costs of offering zero-percent loans.

They may also be able to raise prices, said George Pipas, Ford's chief sales analyst.

Already there are signs prices are on the rise. The average transaction price for a vehicle, despite discounts of nearly $5,200, rose to $23,843 in the first half of June, an increase of about 4 percent from the previous year, according to CNW Marketing Research.

Some analysts do not expect that trend to continue, however. Rising rates could dampen demand for vehicles and more incentives would be required to maintain an annual U.S. sales rate of 16.5 million to 17 million, Bruynesteyn said.

Despite the increased expense, interest-free loans are likely to remain a significant marketing tool for the industry.

"You will see cash play a more prevalent role. You may see leasing play a more prevalent role," Ballew said. "Or at times, it may be zero percent because as interest rates go up, zero percent may be more attractive to consumers."