Loan calculators on financial websites often have a default setting that shows the amount, interest rate, and payment period for a hypothetical loan. But these default settings – which provide an intuitive example of how the calculator works – could do more harm than good.
Corresponding a study published online in the Journal of Behavioral and Experimental Finance in June, depending on the calculator’s default settings, borrowers could be subconsciously manipulated into choosing a more expensive loan.
The researchers found that people were almost twice as likely to choose a longer-term loan when their online calculator defaulted to a five-year loan or longer, compared to participants who defaulted to a one-year loan on their calculator. Extending a loan for even a single year can have a big impact on what borrowers end up paying.
In the study, which was conducted in Ireland, according to Shane Timmons, one of the study’s co-authors and a post-doctoral researcher at the Economic and Social Research Institute in Dublin, Ireland. The other authors were Peter D. Lunn, founder of the Behavioral Sciences Department of the Economic and Social Research Institute and Associate Professor at Trinity College Dublin, and Féidhlim P. McGowan, a former research fellow at the Economic and Social Research Institute who is now working on a PhD .
Monthly loan payment and total interest on a $20,000 loan with an interest rate of 4.5%
The study builds on behavioral economics research showing that people tend to stick to or near default and use reference numbers to make decisions, even when those numbers are completely random.
Researchers have used these findings to encourage employees to set aside more in their 401(k)s or taxpayers to save a certain percentage on their tax returns. Much less research has been done on how defaults affect borrower choice and how lenders might subtly influence their choice, although previous research by Dr. Lunn have shown that when the amount of monthly repayment is emphasized, consumers tend to choose longer-term loans, but when the amount of interest accrued is emphasized, they choose loans with shorter repayment schedules.
The study was funded by the Irish Competition and Consumer Protection Commission. Before starting the research, the Commission, together with the authors of the study, compared the default settings on the lenders’ online calculators with those on the loan calculators on independent websites. They found that loan calculators displayed longer loans, on average — five years on average — than those on independent sites, where the default settings typically displayed one-year loans.
In their study, researchers gave participants a loan calculator and asked them to search for a €10,000 ($11,170) loan.
The 180 participants were randomly divided into two groups. One group used calculators with a one year default and the other group used calculators with a five or more year default. Most participants chose to rate multiple loans using their online calculators.
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dr Timmons had two theories as to why the default setting had the effect it did. First, he says, the calculator’s default setting may have served as a starting point for comparing other loans. Second, participants may have attached importance to default, viewing it as either a social norm telling them the most popular choice or a prescribed norm, a recommendation for the best choice.
Understanding how people interpreted the default setting could help researchers design better interventions. But right now, consumers might be better off making decisions about loans or other types of financial products using online tools from independent websites that don’t have pre-filled information in their online calculator. Only when consumers know exactly which product they want to buy, does Dr. Timmons to go to the lender’s website to look for a loan there.
Ms. Ward is a writer based in Mendham, NJ. Email her at [email protected]
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