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.

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.