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Knowledge of the Cost and Duration of Credit: Effects on Repayment Decisions

Knowledge of the Cost and Duration of Credit: Effects on Repayment Decisions. Rob Ranyard , Sandie McHugh (University of Bolton, UK) Alan Lewis (University of Bath, UK). Issues and Research Questions 1.

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Knowledge of the Cost and Duration of Credit: Effects on Repayment Decisions

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  1. Knowledge of the Cost and Duration of Credit: Effects on Repayment Decisions Rob Ranyard, Sandie McHugh (University of Bolton, UK) Alan Lewis (University of Bath, UK)

  2. Issues and Research Questions 1 • Flexible credit: Duration of credit is not precisely known, especially for longer loans • Does cost information improve estimates of loan duration • APR? • Total interest charged? • See:Ranyard & Craig, 1993, Journal of Economic Psychology 14, 317-335 IAREP/SABE Rome 2008

  3. Issues and Research Questions 2 • Instalment credit, fixed and flexible: • (Mis)understanding APR, the Annual Percentage Rate of interest • Does knowledge of APR improve estimates of the total cost of credit? (Study 1 and Study 2, part 1) IAREP/SABE Rome 2008

  4. Issues and Research Questions 3 • Flexible credit: Long-term consequences of repayment decisions not precisely known • Does information concerning the long term consequences change repayment decisions? • Loan duration? • Total cost? (Study 2, part 2) IAREP/SABE Rome 2008

  5. Flexible credit: Ranyard & Craig, 1993 • Scenario: You want to buy a portable TV and you see the following advert in a store TV (details here) Price: £119.99 (APR 32%) The store offers you a store card .... Minimum repayment £5 ... Interest rate 2.4% per month ... • Question: If you repay £5 (£11) per month, how long will it take you to pay it off? IAREP/SABE Rome 2008

  6. Flexible credit: Ranyard & Craig, 1993 • Results IAREP/SABE Rome 2008

  7. Flexible credit: previous research • Conclusions • APR information reduces the accuracy of flexible credit duration estimates • Because APR misunderstood: some evidence from estimation strategies • Total interest information improves accuracy • Total interest information (or total cost) supports personal financial budgeting IAREP/SABE Rome 2008

  8. Study 1: Understanding APR • Participants and procedure • Survey with 1023 respondents aged 16 and over • interviewed by trained interviewers in 2004 • a quota sample of the U.K. based on gender, age, social and working status and region, weighted to reflect the national profile • The questions form part of a ‘Financial I.Q.’ score designed by the Alan Lewis and collaborators IAREP/SABE Rome 2008

  9. Study 1: Understanding APR • What does A.P.R. stand for? a) Annual Property Revenue b) Annual Perceived Revenues c) Annual Percentage Rate d) April Percentage Rate e) None of the above f) Don't know • Main result • Over 85% correct • significant association with education IAREP/SABE Rome 2008

  10. Study 1: Understanding APR • Many people borrow money to purchase cars or to make household improvements. Say you were to borrow £5,000from one of the major banks to be paid back over 12 months, approximately how much do you think you would pay altogether? Approximately: £5,000 £5,100 £5,400 £5,700 £6,000 don’t know IAREP/SABE Rome 2008

  11. Study 1: Understanding APR • I am going to give you some extra information this time (please keep your answer to the previous question the same). The amount of the loan remains at £5000and the loan repayment period is still 12 monthsbut you now know that the A.P.R. is 8%.How much do you think you would pay back altogether? Approximately: £5,000 £5,100 £5,400 £5,700 £6,000 don’t know • Hypothesis: respondents will over-estimate rather than under-estimate total cost (£5,400 rather than £5,100) IAREP/SABE Rome 2008

  12. Study 1 results: Percent responses, no APRinformation IAREP/SABE Rome 2008

  13. Study 1 results: Percent responses, APR given at 8% IAREP/SABE Rome 2008

  14. Study 2, part 1: Understanding APR • Participants and procedure • Postal survey of 2000 bank customers aged 18 years and over, 240 responses • a random sample of a U.K. Bank’s customers IAREP/SABE Rome 2008

  15. Study 2, part 1: Understanding APR • Many people borrow money to purchase cars or to make household improvements. Say you were to borrow £5,000from one of the major banks to be paid back over 12 months, approximately how much do you think you would pay altogether? Approximately: £5,000 £5,200£5,400 £5,700 £6,000 don’t know IAREP/SABE Rome 2008

  16. Study 2, part 1: Understanding APR • I am going to give you some extra information this time (please keep your answer to the previous question the same). The amount of the loan remains at £5000and the loan repayment period is still 12 monthsbut you now know that the A.P.R. is 8%.How much do you think you would pay back altogether? Approximately: £5,000 £5,200 £5,400 £5,700 £6,000 don’t know • Hypothesis: respondents will over-estimate total cost (£5,400 rather than give the correct response, £5,200) IAREP/SABE Rome 2008

  17. Study 2, part 1 results: response frequencies (n = 234)no APR information IAREP/SABE Rome 2008

  18. Study 2, part 1 results: response frequencies (n = 233)APR given as 8% IAREP/SABE Rome 2008

  19. Study 1 and Study 2, part 1 conclusion • Most (85%) UK adults in the sample knew what APR stands for (associated with education) • But most used it incorrectly, and over-estimate the total cost of credit repaid over 12 months IAREP/SABE Rome 2008

  20. Study 2, part 2: Flexible repayments Mortgage scenario: imagine you have renegotiated your mortgage of £40,000 at an interest rate of 5.9%. How much do you want to pay monthly? IAREP/SABE Rome 2008

  21. Study 2, part 2: Flexible repayments Credit card scenario: imagine you have a £1,500 balance on your credit card at 15.2% APR. How much do you want to pay monthly? IAREP/SABE Rome 2008

  22. Study 2, part 2: Flexible repayments • Independent groups, 2 x 2 factorial design • Total Cost information (TC given vs. No TC) • Loan Duration information (Duration give vs. No duration) • Four versions of questionnaire, participants randomly allocated to one condition IAREP/SABE Rome 2008

  23. Study 2, part 2: Results – Credit cardPercent responses, all groups IAREP/SABE Rome 2008

  24. Study 2, part 2: Results – MortgagePercent responses by group

  25. Study 2, part 2: Conclusion • In the mortgage scenario • information concerning long-term consequences significantly influenced repayment decisions • Higher repayments were chosen when either total cost or duration information was provided • In the credit card scenario • information concerning the long-term consequences of repayment decisions had no effect • Participants generally preferred the highest repayment of those available IAREP/SABE Rome 2008

  26. General Conclusions • APR provides useful cost information but it can be misleading; Total cost information should be presented in addition • Both total cost and duration information are important for budgeting with flexible credit and can influence repayment decisions IAREP/SABE Rome 2008 26

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