Loan selection, attribute substitution and information effect

Purpose - Borrowers are usually presented with a menu of similar-looking options when selecting a loan plan. However, it remains unclear whether they are able to choose the most cost-effective plan. This study aims to investigate whether people select loan plans optimally, whether their choices are influenced by the informational cues provided to them and how their selections change with the provision of additional loan-related information. Design/methodology/approach - The study uses a within-participant experimental design, where participants are presented with similar-looking loan plans but with different present discounted costs. Subjects are asked to rank those plans, with the minimum present discounted cost plan maximizing their experimental payoff. The loan plans across different rounds are presented with different informational cues to see whether that influences participants' ability to select the cost-minimizing loan plans. Findings - The author finds that participants were 78% likely to state a suboptimal preference ordering and 68% likely to select a loan plan that does not minimize cost. There is suggestive evidence regarding the role of attribute substitution in the decision-making process, wherein participants substituted annual percentage rate (APR) and total cost attributes for the present discounted cost of a loan plan. Additionally, the author presents causal evidence demonstrating how providing additional information can influence the choice of the substituted attribute. Originality/value - Research has indicated that individuals often make suboptimal financial decisions, particularly in complex decision contexts. Examples include selecting medical insurance, a retirement savings plan, a student loan or borrowing on a credit card. This paper demonstrates that similar biases are present when individuals borrow using a loan plan, wherein they tend to substitute the APR or total cost of the loan plan for the present discounted cost of the loan plan. Furthermore, the study reveals that the impact of providing more information to borrowers can vary, depending on the combination of loan plans being considered.