Consumer loans with fixed monthly payments

Abstract

Consumers tend to have problems interpreting cost information, such as the annual percentage rate (APR), pertaining to loans. Students were used to test people's spontaneous estimates of loan cost when only the payment pattern was known, but not the APR or the total finance charge (FC). Experiments show that some absolute measures such as the FC seem to be used rather than relative measures when ranking loans. This leads to a bias against loans of longer duration. This can be avoided by using a heuristic, an approximate APR, by a simple development of the FC. The last section examines the problem of estimating the duration change when the interest rate is altered. Experiments show that the duration is generally underestimated when only the payment pattern and the interest rate are known. If the FC per month is known the situation improves somewhat, but still the effects on the duration of changing interest rates are underestimated.