ESRI study finds consumers are confused by personal loans

Consumers find personal loans confusing and struggle to choose the right one, according to a new piece of research published by the ESRI’s new behavioural economics unit this morning.

The research also shows that consumer confusion which leads to mistakes in choosing the best value financial product could end up costing some consumers many thousands of euro over the lifetime of a loan.

The report is based on experiments conducted in the research body's Price Lab – a programme jointly funded by the Central Bank of Ireland, the Commission for Communications Regulation, the Commission for Energy Regulation and the Competition and Consumer Protection Commission.

It shows that consumers find it hard to understand how the length of a loan affects both the size of monthly repayments and the overall amount it costs to borrow which can lead to inconsistent and disadvantageous choices.

A series of experiments carried out in the Price Lab tested whether consumers’ decisions were affected by which information was made explicit in a given offer.

The results showed that consumers chose to pay the loan back over a longer period when the size of the monthly repayments was highlighted than when the overall financial cost was highlighted. The inconsistency sometimes equated to thousands of euro over the course of a loan.

The Lab also tested two policy interventions, or “nudges”, designed to help consumers to make better decisions in the personal loans market.

A “high cost loan” warning was found to reduce the chances that consumers opted for loans with above average interest rates.

Providing consumers with a specific table of example loans before they made their choices also helped them to make more consistent decisions. This is the first time that interventions have been experimentally pre-tested like this in Ireland.

“Our experiments suggest consumers could be vulnerable to certain marketing techniques, which are likely to tempt them towards longer loans that ultimately cost more,” said Dr Pete Lunn Principal Investigator. Yet our results also point to ways we can help consumers to make better choices in this market. ”

The Programme of Research Investigating Consumer Evaluations) - or Price Lab - focuses on how consumers make decisions when faced with multi-attribute products, with the aim of providing evidence for consumer policy.

The programme has developed methods for assessing the quality of consumers’ decision-making. The present report applies these methods to investigate consumer choice in the market for personal loans.

The authors of the report suggest that while evidence exists that there are benefits associated with the two ‘nudges’ tested the “impact of these interventions would be unlikely to be large”.

The results also suggest a number of possible regulatory interventions that have the potential to help consumers to make better decisions, by exposing them to useful information at key points in the decision process. “However, the likely outcomes are far from definitive,” the report says and “further analysis and empirical tests are required to generate better evidence for policy.”