Transparency in Consumer Credit: The Usage of the APR

Abstract

The role of Annual Percentage Rate (APR) in installment plan selection was investigated. The choice of analyzing APR was motivated by its wide diffusion due to the mandatory disclosure acts. There have been doubts towards consumer understanding of APR.A sample of 299 consumers were given five series of credit alternatives. The descriptions of the loans were homogeneous and regarded amount borrowed, duration, monthly installment, APR, total repayments, and opportunity cost of capital. Consumers were asked to select a credit option for each series clarifying the motivations of their choice.The ability to select the loan with the highest Net Present Value (NPV) was ascertained. It depends on the awareness of (i) opting for the lowest APR, that is also less than the opportunity cost of capital; and (ii) demanding the extension of the repayment period to improve the convenience of the identified competitive rate.The analysis attested consumer failure to single out the loan with the highest NPV. The reason should be a considerable lack of information about the usage of APR: participants selected the lowest rate but they neglected to consider the opportunity cost of capital and the extension of the repayment period. Furthermore, they sometimes chose the loan contrasting duration and monthly borrowing costs. APR usage may therefore be inapt since employed as a substitute for the monthly installment payment. An overlap between economic convenience and financial sustainability could explain this phenomenon. To improve disclosure, further (or different) borrowing cost measures should be placed in credit advertisements. This is one of the few studies that measure ability to select installments plans considering effects of information availability.JEL classification: G21, G28, D82

Impact of Financial Education and Transparency on Borrowing Decisions: The Case of Consumer Credit

“…Consequently, is the most probably rate charged to an applicant. For greater details, refer to Caratelli (2010).…”