Risk-based Pricing of Interest Rates in Household Loan Markets
AbstractAbstract: Focusing on observable default risk's role in loan terms and the subsequent consequences for household behavior, this paper shows that lenders increasingly used risk-based pricing of interest rates in consumer loan markets during the mid-1990s. It tests three resulting predictions. First, the premium paid per unit of risk should have increased over this period. Second, debt levels should react accordingly. Third, fewer high-risk households should be denied credit, further contributing to the interest rate spread between the highest- and lowest-risk borrowers. For those obtaining loans, the premium paid per unit of risk did indeed become significantly larger over this time period. For example, given a 0.01 increase in the probability of bankruptcy, the corresponding interest rate increase tripled for first mortgages, doubled for automobile loans and rose nearly six times for second mortgages. Additionally, changes in borrowing levels and debt access reflected these new pricing practices, particularly for secured debt. Borrowing increased most for the low-risk households who saw their relative borrowing costs fall. Furthermore, while credit access increased for very high-risk households, the increases in their risk premiums implied that their borrowing as a whole either rose less or, sometimes, fell.
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 442.
Date of creation: 2004
Date of revision:
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
Web page: http://www.EconomicDynamics.org/society.htm
More information through EDIRC
Consumer Loans; Consumption; Risk-Based Pricing;
Find related papers by JEL classification:
- D1 - Microeconomics - - Household Behavior
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- E2 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-08-02 (All new papers)
- NEP-MIC-2004-08-02 (Microeconomics)
- NEP-RMG-2004-08-02 (Risk Management)
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