The Behavioral Economics of Title Lending

This week we have discussed some of the interesting facts our recent research has uncovered about the title lending industry and its borrowers. One of the goals of our research is to use economics tools, from both neo-classical and behavioral economics, to develop a broader understanding of how borrowers are making choices in this market.

Because, as we discussed before, repossession in this market is rare, we do not think the potential loss of one’s car is actually at the center of consumers’ choices in this market. What we uncovered in our study is that the costs associated with title lending can be high, especially if borrowers use the loans for extended periods of time.  And borrowers often underestimate their future ability to repay as well as the sums of required payments to the lenders.

Our behavioral economics work in this area is motivated by the new and growing literature on other markets (for example, payday loans and credit cards) that documents behavioral anomalies like self-control problems and overoptimism.

We do find that borrowers seem smart and rational in that they appear to learn from using the loans and get better at predicting their own usage patterns over time. We expect that customers familiar with the title loan product and with their own behavior might learn about themselves and become less overoptimistic over time. We assessed this knowledge by asking customers, “How many months total do you think it will take to completely pay off this loan (after all renewals/rollovers?)” The results are shown below.

 Optimism and Learning:

	First loan		Not first loan
	Percentage	Count	Percentage	Count
1 month	30%	15	15.48%	13
2–3 months	40%	20	40.48%	34
4–5 months	14%	7	13.10%	11
6+ months	16%	8	30.95%	26
Total	100%	50	100%	84

In this table we compare the answers of customers taking out a loan for the first time with the answers of customers who had used a title loan before. Fewer people who had used a title loan before think they would pay off the loan in one month than people taking out a loan for the first time did. Similarly, more people who have used title loans in the past think it will take them six or more months to pay off the loan than those who have never used one. Thus, it appears that customers do learn about the latent risk of title borrowing through experience.

 

We think regulators should incorporate research on how consumers actually make choices in this market when they consider potential regulations. Policymakers can improve efficiency in title lending markets by requiring lenders to disclose how customers are likely to use their title loans rather than merely requiring lenders to communicate pricing information.

 Image from Shutterstock.