Beware of online loan calculators – WSJ

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.

According to a study published online in the Journal of Behavioral and Experimental Finance in June, borrowers could be unknowingly manipulated into choosing a more expensive loan, depending on the calculator’s default settings.

The researchers found that people were almost twice as likely to choose a longer-term loan if their online calculator’s default setting had a five-year loan or longer, compared to participants who had a loan of five years or more. one year as the default setting 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, participants had to pay the equivalent of about $522 extra when they chose a four-year loan over a three-year loan, according to Shane Timmons, l one of the study’s co-authors and a post-doctoral researcher at the Institute of Economic and Social Research in Dublin, Ireland. The other authors were Peter D. Lunn, founder of the Behavioral Research Unit at the Institute for Economic and Social Research and adjunct professor at Trinity College Dublin, and Féidhlim P. McGowan, former research assistant at the Institute of economic and social research, now working on a doctorate.

Growing interest

Monthly loan payment and total interest paid on a $20,000 loan, with an interest rate of 4.5%

The study draws on behavioral economics research showing that people tend to stay at or near the default setting and use reference numbers to make choices, even if those numbers are completely random.

The researchers used this information to encourage employees to put more aside in their 401(k) or taxpayers to save a certain percentage of their tax refunds. There has been much less research on how defaults influence the loans borrowers choose and how lenders might subtly influence their choices, although previous research by Dr Lunn has shown that when the size of a monthly repayment is highlighted, consumers tend to choose longer-term loans. loans, but when the amount of accrued interest is highlighted, they choose loans with shorter repayment schedules.

The Irish Competition and Consumer Protection Commission funded the study. Before the research began, the commission and study authors compared the default settings of lenders’ online calculators with those of loan calculators from independent websites. They found that lenders’ calculators tended to show longer loans (five years on average) than those on independent sites, where the default settings typically showed loans with a one-year term.

In their study, the researchers gave participants a loan calculator and asked them to research a loan of €10,000 ($11,170).

The 180 participants were randomly divided into two groups. One group used calculators with a default setting of one year, and the other group used calculators with default settings of five years or more. Most participants chose to assess multiple loans with their online calculator.

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Dr. Timmons had two theories as to why the default setting had this effect. First, he says, the calculator’s default setting may have served as a starting point for comparing other loans. Second, participants may have attached meaning to the default setting, viewing it either as a social norm, telling them which choice is most popular, or as a prescriptive norm, a recommendation about the best choice.

Understanding how people interpreted the default setting could help researchers design better interventions. But for now, consumers might be better off if they make decisions about loans or other types of financial products using online tools from independent websites that don’t have pre-populated information in their online calculator. It’s only when consumers know exactly what product they want to buy that Dr. Timmons advises going to the lender’s website to purchase a loan.

Ms. Ward is a writer in Mendham, NJ Email her at reports@wsj.com.

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