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Understanding and knowledge of credit cost and duration: Effects on credit judgements and decisions

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  • McHugh, Sandie
  • Ranyard, Rob
  • Lewis, Alan

Abstract

Financial capability requires understanding measures of consumer credit cost and using them appropriately in credit judgements and decisions. In three studies, UK adults' understanding and use of credit cost and duration information were investigated from a bounded rationality perspective. Study 1, part of a representative survey of UK adults (NÂ =Â 1000), found that when presented with annual percentage rate (APR) participants significantly overestimated the total cost (TC) of a 12-month loan. In Study 2, loan duration and APR were varied in an independent groups experiment (NÂ =Â 242). Bank customers' TC estimates were sensitive to both loan duration and APR but TC was again substantially overestimated. Study 3 was an independent groups experiment investigating the effect of APR and TC information on credit decisions (NÂ =Â 241). APR often influenced decisions between loans varying in duration and monthly repayment, but this effect was moderated by TC information. It was concluded that: (1) people generally misunderstand the relation between APR and TC; and (2) although APR information can have a large effect on credit decisions, its effect is either attenuated or amplified by TC information. The findings are interpreted in terms of a 'take the best APR' heuristic and a dual mental account model of instalment credit. Recommendations for improving credit information provision and financial education are offered.

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  • McHugh, Sandie & Ranyard, Rob & Lewis, Alan, 2011. "Understanding and knowledge of credit cost and duration: Effects on credit judgements and decisions," Journal of Economic Psychology, Elsevier, vol. 32(4), pages 609-620, August.
    • Handle: RePEc:eee:joepsy:v:32:y:2011:i:4:p:609-620
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    3. Lunn, Pete & McGowan, Féidhlim & Howard, Noel, 2018. "Do some financial product features negatively affect consumer decisions? a review of evidence," Research Series, Economic and Social Research Institute (ESRI), number RS78.
    4. McHugh, Sandie & Ranyard, Rob, 2016. "Consumers’ credit card repayment decisions: The role of higher anchors and future repayment concern," Journal of Economic Psychology, Elsevier, vol. 52(C), pages 102-114.
    5. Gathergood, John, 2012. "Self-control, financial literacy and consumer over-indebtedness," Journal of Economic Psychology, Elsevier, vol. 33(3), pages 590-602.
    6. Lin, Chaonan & Hsiao, Yu-Jen & Yeh, Cheng-Yung, 2017. "Financial literacy, financial advisors, and information sources on demand for life insurance," Pacific-Basin Finance Journal, Elsevier, vol. 43(C), pages 218-237.
    7. Shen, Chung-Hua & Lin, Shih-Jie & Tang, De-Piao & Hsiao, Yu-Jen, 2016. "The relationship between financial disputes and financial literacy," Pacific-Basin Finance Journal, Elsevier, vol. 36(C), pages 46-65.
    8. Lunn, Pete & Bohacek, Marek & Rybicki, Alicia, 2016. "An Experimental Investigation of Personal Loan Choices," Research Series, Economic and Social Research Institute (ESRI), number BKMNEXT314.

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