When irrelevant alternatives do matter. The effect of focusing on loan decisions

Abstract

In this paper we investigate some implications of recent results about salience on loan decisions. Using the framework of focus-weighted utility we show that consumers might take out loans even when that yield them negative utility due to the focusing bias. We suggest, however, that this can be counterbalanced and consumers might be more prudent in their decisions and less likely to take out such loans when the usual fixed-installments plan is coupled with an equivalent decreasing-installments option. Moreover, we show that this is true even for loans with prepayment options or when borrowers take default into consideration. We argue that harmful loan consumption could be decreased if a policy would prescribe presentation of loan repayment schedules in a way that employs this effect.

Exploiting context-dependent preferences to protect borrowers

“…Another important aspect of the loan decision-making process is that consumers are inclined to compare their options (including the option of not borrowing and thus not purchasing) to each other and evaluate them on their mutual attributes (Kamleitner and Kirchler 2006;Hoelzl et al 2009;Kamleitner et al, 2010;Hoelzl et al 2011;Kőszegi and Szeidl, 2013;Bakó et al, 2018). Consequently, they compare the available options to each other and choose the option which seems to bring them the highest benefit within the set.…”

“…In a loan decision, consumers attend excessively to (i.e., focus more on) the difference between getting the loaned amount and not, while attending much less to the remote and seemingly minor differences between making and not making repayments. Consequently, the consumer maximizes his/her focus-weighted utility on the spot of a loan decision, which falls below what s/he realizes with the consumption after the selected option is removed from the choice set (Kőszegi and Szeidl 2013;Friztdixon et al 2014;Bakó et al 2018).…”

“…In particular, we argue and demonstrate that carefully designing the context in which loan plans are offered could result in a systematic change in the preference for loan consumption, and ultimately deter consumers from borrowing. This idea was first fleshed out in a theoretical paper by Bakó et al (2018), henceforth denoted as BND.…”

The Analysis of Focusing Illusion and Irrational Behavior in the Field of Consumption

“…Moreover, it could have further financial impact on individuals purchasing vehicles, as a relatively large number of individuals purchase vehicles using auto-loans. Focusing illusion affects individual's minds, in terms of decision making on whether and which auto-loans should be purchased, and unsuitable option would bring undesired harms of loan consumptions on individuals or households [4]. For instance, when multiple loan plans are presented simultaneously, they could be compared by consumers through common attributes such as interest rates and monthly instalments.…”