A note on the perceptions of loan duration and repayment

JOURNAL OF

ELSEVIER Journal of Economic Psychology 16 (1995) 161-168

A note on the perceptions of loan duration and repayment

Alan Lewis a, , , Marlies van Venrooij b

a School of Social Sciences, University of Bath, Claverton Down, Bath, BA2 7AY, UK b University of Tilburg, Tilburg, The Netherlands

Received 7 March 1994; accepted 22 December 1994

Abstract

This study builds on the work of Ranyard and Craig (1993) on the estimation of the duration of loans. 119 undergraduates starting their loan and debt 'careers', a small sample of final year undergraduates (N = 20) the majority of whom described themselves as being in debt, and a sample of young women still at school ( N = 39) with no commercial experience of borrowing, estimated the duration of loans under three 'information' conditions and three 'repayment' conditions. There was some evidence that improved estimations resulted from supplementary information about 'total interest' for 'fixed' loans in a similar way to the results recorded by Ranyard and Craig for 'flexible' loans. Again as Ranyard and Craig recorded, underestimations were most evident for longer repayment periods (with low individual repayments). People with experience of debt rarely underestimate, but there is a great deal of confusion about the meaning of 'interest' among young people with no experience of credit. This warrants further investigation of financial perceptions across a wider age and 'credit experience' range.

I. Introduction

In a recent paper published in this journal Ranyard and Craig (1993) investigated the effect of supplementary information on the estimation of the duration of flexible loans. The main results revealed that estimations

Corresponding author. E-mail: [email protected]; Fax: +44 225 826381; Tel.: +44 225 826826.

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162 A. Lewis, M. van Venrooij /Journal of Economic Psychology 16 (1995) 161-168

improved when information was supplied about average monthly interest charges; estimations were made slightly worse when information was supplied about the annual percentage rate of interest (APR), information required by law in the UK. When information was supplied about total interest charges this proved the best option of all improving loan duration estimation substantially. When underestimations occurred they were more pronounced when repayment periods were lengthy (and individual repayment amounts relatively small).

The mental arithmetic required to work out repayment periods for flexible loans is complex: the present study applies a similar method to Ranyard and Craig in order to investigate estimations of the duration of 'fixed' loans where the calculations are much more straightforward. The aim was to see whether Ranyard and Craig's results for 'monthly interest ' and 'total interest ' would apply to 'fixed' loans as well as to flexible loans.

Ranyard and Craig's sample comprised 'mature ' students as participants. The current study samples the estimates of first year undergraduates, the majority of whom were twenty one years old or younger, supplemented by information from students shortly to graduate and from young women of seventeen and eighteen years of age in their final year of schooling, thus providing an opportunity (albeit a limited one given the small sample sizes) of comparing young people starting, or about to start, their 'credit careers' with those with more experience.

2. Method

2.1. Participants

A total of 119 University of Bath first year undergraduate students formed the bulk of the respondents to a questionnaire on debt and borrowing. All the undergraduates were attending an introductory course in psychology but were majoring in a variety of subjects including social policy, social work, sociology, economics and politics as well as psychology; approximately 20% were 'mature ' students (i.e. over 25 years of age).

Two further preliminary sub-samples were taken as a possible guide to age and socialisation effects. The first was a sample of 39 young women in their final or penult imate year at high school (the 6th form of an independent fee-paying secondary school in Bath). Most of these participants were not in a position, nor did they wish to borrow money from the commercial sector, although they would soon be able (and willing) to do so. If money

A. Lewis, M. van Venrooij /Journal of Economic Psychology 16 (1995) 161-168 163

was borrowed it was borrowed informally, mainly from parents. The second sub-sample was of 20 undergraduate students in their final (4th) year of study for the degree in psychology and sociology. This group of students would in the past few years have had their first experiences of borrowing money and, as is the norm in the USA and elsewhere, and fast becoming so in the United Kingdom, the majority of them would have had to take out loans to finance their education. Students commonly leave university after graduation with substantial debts.

2.2. The questionnaire

The questionnaire was in three versions, namely 'basic', 'monthly interest' and 'total interest'. Only one of the three was seen by any single participant. All the versions posed six related questions. The first set of three enquired how long £120 borrowed from a bank would take to pay back, in terms of months, when the repayments were respectively £5, £11, and £18 per month. The second set of three enquired how much in total would be paid back if the repayments were respectively £5, £11 and £18. The 'basic' version presented the information as described above and nothing more; the 'monthly interest ' version provided the average monthly interest rate of 2.4% as additional information, the 'total interest ' version presented the total amount of interest that would be due, namely £60.88 for the £5.00 repayments, £20.44 for the £11.00 repayments, and £18.34 for the £18.00 repayment.

Participants were told that the questions might take a little time to answer and should be considered carefully.

A series of independent variables were recorded including sex, age, marital status, whether participants currently held credit cards, had loans or were, in their own terms, in debt. Income was also recorded, based on participants' perceived family income for those under 23 years of age, and their own family income, where appropriate, for older participants.

3. Results

Table 1 presents the means (and standard deviations) for the estimated length of the repayment period ( 'How long is the repayment period?') for each repayment and ' information' condition and for each of the sub-sam- pies. Table 2 has an identical structure, presenting the means (and standard deviations) for the answer to the question 'What is the total amount to be repaid?'.

4~

Tab

le 1

H

ow l

ong

is t

he r

epay

men

t pe

riod

?

£5 p

er m

onth

rep

aym

ent

£11

per

mon

th

£18

per

mon

th

'Bas

ic'

'Mon

thly

'T

otal

'B

asic

' 'M

onth

ly

'Tot

al

'Bas

ic'

'Mon

thly

'T

otal

in

tere

st'

inte

rest

' in

tere

st'

inte

rest

' in

tere

st'

inte

rest

'

Fin

al y

ear

unde

rgra

duat

es

24 (

1)

31 (

6)

37 (

2)

13 (

2)

14 (5

) 13

(1)

8

(2)

10 (

4)

8 (1

) (N

= 2

0)

Fir

st y

ear

unde

rgra

duat

es

27 (

7)

28 (

10)

34 (

6)

12 (3

) 14

(5)

13

(2)

8

(2)

8 (3

) 9

(3)

(N =

119

) ll

th a

nd 1

2th

grad

ers

(UK

6th

for

m)

26 (

6)

32 (

20)

32 (

7)

12 (3

) 12

(2)

13

(3)

7

(2)

11 (

9)

8 (4

) (N

= 3

9)

Cor

rect

ans

wer

s 36

mon

ths

13 m

onth

s 8

mon

ths

P.

Not

e: E

ntri

es a

re m

ean

esti

mat

ed d

urat

ions

in

mon

ths,

rou

nded

to

the

near

est

mon

th.

Sta

ndar

d de

viat

ions

are

giv

en i

n pa

rent

hese

s.

L

Tab

le 2

W

hat

is t

he t

otal

am

ount

to

be r

epai

d?

£5 p

er m

onth

rep

aym

ent

'Bas

ic'

£11

per

mon

th

£18

per

mon

th

'Mon

thly

'T

otal

'B

asic

' 'M

onth

ly

'Tot

al

'Bas

ic'

'Mon

thly

'T

otal

in

tere

st'

inte

rest

' in

tere

st'

inte

rest

' in

tere

st'

inte

rest

' ga

Fin

al y

ear

unde

rgra

duat

es

£161

(20

) (N

= 2

0)

Fir

st y

ear

unde

rgra

duat

es

£176

(74

) (N

= 1

19)

llth

and

12t

h gr

ader

s (U

K 6

th f

orm

) £1

45 (

49)

(N =

39)

£198

(3)

£1

80(0

)

£189

(43)

£1

83 (

20)

£210

(271

) £2

50(2

49)

Cor

rect

ans

wer

s £1

80

£146

(17

) £1

68(2

7)

£139

(4)

£151

(53

) £1

57 (

44)

£142

(10

)

£136

(46)

£1

93 (

271)

£1

86(1

38)

£141

£134

(10

) £1

53 (

19)

£138

(0)

£141

(35

) £1

47(6

1)

£138

(9)

£127

(42

) £1

16 (

52)

£177

(94

)

£138

Not

e: E

ntri

es a

re m

ean

esti

mat

ed a

mou

nts

roun

ded

to t

he n

eare

st £

. S

tand

ard

devi

atio

ns a

re g

iven

in

pare

nthe

ses.

L

O~


A series of one-way A N O V A were undertaken (using SPSSPC + ) as- sessing the main effect of the information versions ('basic', 'monthly interest ' and 'total interest') for all the sub-samples combined for each repayment condition in turn. Significant differences were recorded for the £5 repayment condition in answer to the question 'How long is the repayment period?' ( F = 9.92, p <0.001) but not for the £11 and £18 repayment conditions. Fur ther one-way A N O V A tests revealed similar results for the sub-sample of fourth year undergraduates (£5 'How long?' F = 22.5, p < 0.001) and first year undergraduates (£5 'How long?' F = 7.89, p < 0.001) but not for the l l t h / 1 2 t h graders (UK 6th formers).

There were no significant differences between information versions for any of the repayment conditions in the answer to the question 'What is the total amount to be repaid?' for the combined sub-sample. Similar statistically non-significant results were recorded for the l l t h / 1 2 t h graders and first year undergraduates but not, interestingly, for the fourth year undergraduates where the information versions proved significantly different for all three repayment conditions (£5: F = 4.5, p < 0.05; £11: F = 4.1, p < 0.05; £18: F = 4.2, p < 0.05).

Looking at the background variables next, 38% of participants had credit cards among first year undergraduates, 15% said they had a loan, and 15% described themselves as being in debt. By year four things were rather different: 50% had credit cards, 44% had loans and the majority describe themselves as being in debt (67%). As one might expect only a handful of l l t h and 12th graders had credit cards, although two individuals did nonetheless describe themselves as being in debt.

A N O V A and t-tests were under taken to assess the influence of background variables on the conditions. There were no clear differences for any of the independent variables with the notable exception of the debt question: those in debt among the first year undergraduates were more likely to give higher estimates for the 'How much?' question of the £5 repayment condition (t = 2.44, dr= 96, p = 0.017), £11 repayment condition (t = 3.03, df= 91, p = 0.003) and £18 repayment condition (t = 2.51, df = 92 p = 0.014).

4. Discussion and conclusions

The influence of the different versions, i.e. of the different descriptions of the loans, was most marked in the £5 repayment condition, when

A. Lewis, M. van Venrooij /Journal of Economic Psychology 16 (1995) 161-168 167

participants were asked to estimate the length of the loan: statistically significant results were obtained for both the undergraduate samples. The length of the loan was persistently underest imated, especially in the 'basic' version where no mention of interest was made, but also in the 'monthly interest ' where the average monthly rate was introduced; estimates were at their most accurate where the total amount of interest charged was present ( 'total interest ' version).

These results have similarities to those recorded by Ranyard and Craig (1993) for 'flexible loans' where underestimations were also pronounced for lengthier (and lower repayment) loans and where the greatest accuracy was in the ' total interest' condition.

Looking next at estimates of the total amount to be repaid, there was also a tendency (although the statistical evidence is not strong) for the ' total interest ' charged version to produce the most accurate estimates in both undergraduate samples. The standard deviations presented in the table reveal that the ' total interest ' conditions produced the greatest amount of agreement among participants: all of the final year undergraduates arrived at the correct answer for the £5 and £18 repayment conditions.

The results from the l l t h / 1 2 t h graders show very large standard deviations in Table 2 especially for the 'monthly interest ' and 'total interest ' conditions; it is as though supplementary information causes confusion. This view gains credence from the result that some 60% of these pupils agreed that a bank would charge no interest at all on loans (the 'basic' condition).

Future studies should aim to obtain some qualitative information, as it is as yet unclear how people use the interest information. Related problems arise because of the sums involved. For example in the £5.00 condition, where the majority of the statistical differences were located, ignoring interest produces large differences between versions; this is not the case for the £11.00 and £18.00 conditions where a straightforward division of the total sum borrowed by 11 and especially 18 produces answers close to the correct one even when interest is ignored.

A note of optimism can be drawn from the result that people with experience of debt (more than half of the sample of final year undergraduates) no longer underest imated the amounts to be repaid, in fact they overestimated them in all the repayment conditions, and these differences were statistically significant.

The finding that so few disaggregations of economic perceptions by independent variables proved statistically significant suggests a certain


robustness in the findings but implies also that similar studies need to be carried out with participants from a wider age, income and educational background.

The underestimation of the lowest repayment regime, which in terms of total repayment constitutes the most expensive option, is worrying if one is concerned about reducing debt problems and increasing appropriate and responsible borrowing; it is usually the less wealthy who choose the lowest repayments. And like Ranyard and Craig (1993) before us (when discussing 'flexible' loans) we would argue that the most obvious policy implication is to encourage lenders to display most prominently, not the APR, but the total amount of interest charged even for 'fixed' loans.

Acknowledgement

The authors acknowledge the helpful remarks of the two anonymous referees.

Reference

Ranyard, R. and G. Craig, 1993. Estimating the duration of a flexible loan: The effect of supplementary information. Journal of Economic Psychology 14, 317-335.

Documents

A note on the perceptions of loan duration and repayment