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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
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    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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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economic Psychology.

    Volume (Year): 32 (2011)
    Issue (Month): 4 (August)
    Pages: 609-620

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    Handle: RePEc:eee:joepsy:v:32:y:2011:i:4:p:609-620

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    Web page: http://www.elsevier.com/locate/joep

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    Keywords: Consumer credit Decision making Annual percentage rate Total cost Mental accounting Decision heuristics;

    References

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    1. Adele Atkinson & Stephen McKay & Sharon Collard & Elaine Kempson, 2007. "Levels of Financial Capability in the UK," Public Money & Management, Chartered Institute of Public Finance and Accountancy, vol. 27(1), pages 29-36, 02.
    2. Marianne Bertrand & Dean Karlin & Sendhil Mullainathan & Eldar Shafir & Jonathan Zinman, 2005. "What's Psychology Worth? A Field Experiment in the Consumer Credit Market," NBER Working Papers 11892, National Bureau of Economic Research, Inc.
    3. Ranyard, Rob & Craig, Gill, 1993. "Estimating the duration of a flexible loan: The effect of supplementary information," Journal of Economic Psychology, Elsevier, vol. 14(2), pages 317-335, June.
    4. Richard Thaler, 1985. "Mental Accounting and Consumer Choice," Marketing Science, INFORMS, vol. 4(3), pages 199-214.
    5. Drazen Prelec & George Loewenstein, 1998. "The Red and the Black: Mental Accounting of Savings and Debt," Marketing Science, INFORMS, vol. 17(1), pages 4-28.
    6. Ranyard, Rob & Craig, Gill, 1995. "Evaluating and budgeting with instalment credit: An interview study," Journal of Economic Psychology, Elsevier, vol. 16(3), pages 449-467, September.
    7. Bettman, James R & Luce, Mary Frances & Payne, John W, 1998. " Constructive Consumer Choice Processes," Journal of Consumer Research, University of Chicago Press, vol. 25(3), pages 187-217, December.
    8. Shefrin, Hersh M & Thaler, Richard H, 1988. "The Behavioral Life-Cycle Hypothesis," Economic Inquiry, Western Economic Association International, vol. 26(4), pages 609-43, October.
    9. Ranyard, Rob & Hinkley, Lisa & Williamson, Janis & McHugh, Sandie, 2006. "The role of mental accounting in consumer credit decision processes," Journal of Economic Psychology, Elsevier, vol. 27(4), pages 571-588, August.
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    Cited by:
    1. Ranyard, Rob & McHugh, Sandie, 2012. "Defusing the risk of borrowing: The psychology of payment protection insurance decisions," Journal of Economic Psychology, Elsevier, vol. 33(4), pages 738-748.
    2. John Gathergood, . "Self-Control, Financial Literacy and Consumer Over-Indebtedness," Discussion Papers 12/02, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).

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