Repayment Decisions Research Articles

THE IMPACT OF LEARNING ON BUSINESS CYCLE FLUCTUATIONS IN THE CONSUMER UNSECURED CREDIT MARKET

We document that the credit spread on consumer unsecured debt exhibits a persistent, hump-shaped response to an increase in the charge-off rate. This stylized fact poses a significant challenge for a standard model of consumer default in which lenders have rational expectations and, therefore, the credit spread continuously adjusts to reflect the true default incentives of each borrower. In an effort to explain this feature of the data, we construct a model of consumer default with countercyclical income risk in which lenders learn about default risk over time by observing the history of repayment decisions, as is the case in practice. In addition to matching credit spread dynamics, allowing lenders to learn about default risk substantially improves the model’s ability to generate realistic business cycle fluctuations in the consumer unsecured credit market and match the cross-sectional distribution of unsecured debt and dispersion of interest rates observed in the data.

The Impact of Credit Scoring on Credit Spreads and Consumption Over the Business Cycle

Unsecured debt is the marginal source of finance for most consumers. Short run fluctuations in the credit spread on consumer unsecured debt, therefore, likely have important implications for consumer welfare. We document that the credit spread on consumer unsecured debt exhibits a persistent, hump-shaped response to an increase in the charge-off rate. This stylized fact poses a significant challenge for a standard model of consumer default in which lenders have rational expectations and, therefore, the credit spread continuously adjusts to reflect the true default incentives of each borrower. In an effort to explain this feature of the data, we construct a model of consumer default with countercyclical income risk in which lenders learn about default risk over time by observing the history of repayment decisions, as is the case in practice. In addition to matching credit spread dynamics, allowing lenders to learn about default risk substantially improves the model's ability to generate realistic business cycle fluctuations in the consumer unsecured credit market and match the cross-sectional distribution of unsecured debt and dispersion of interest rates observed in the data.

Minimum payments and debt paydown in consumer credit cards

Using a data set covering one quarter of the U.S. general-purpose credit card market, we document that 29% of accounts regularly make payments at or near the minimum payment. To explain the prevalence of low payment amounts, we exploit changes in issuers’ minimum payment formulas to quantify the explanatory power of two potential theories: liquidity constraints and anchoring. At least 22% of near-minimum payers (and 9% of all accounts) respond to the formula changes in a manner consistent with anchoring as opposed to liquidity constraints alone. Our results show that anchoring to a salient contractual term has a significant impact on household repayment decisions.

A FATAL FLAW: DOMESTIC BANKS AND MEXICO’S INTERNATIONAL NEGOTIATING POSITION IN THE 1982 DEBT CRISIS

AbstractThe recent European debt crisis has renewed interest as to why debtor countries honour their foreign debts and subscribe to respectively burdensome rescheduling conditions. While the cost of defaulting in a domestic financial system has been recognised as a main motive for repayment, the factors that cause sovereign states to refrain from debt repudiation are not fully understood. This article investigates the reasons behind the repayment decision and weak negotiating position of the Mexican government following the 1982 debt crisis. It shows that leading commercial banks had considerable amounts of external loans in their books, and that Mexican policymakers lacked the foreign exchange access they needed to secure the stability of the domestic banking system. The high exposure of domestic banks to Mexican debt and their heightened dependence on foreign capital worked as mechanisms that allowed international creditors to enforce their claims and deterred Mexico from declaring a unilateral default.

Age differences in financial decision making:The benefits of more experience and less negative emotions

AbstractThe emerging literature on aging and decision making posits that decision‐making competence changes with age, as a result of age differences in various cognitive and noncognitive individual‐differences characteristics. In a national life‐span sample from the United Kingdom (N = 926), we examined age differences in financial decisions, including performance measures of sunk cost and credit card repayment decisions, and self‐report measures of money management and financial decision outcomes. Participants also completed four individual‐differences characteristics that have been proposed as relevant to financial decision making, including two cognitive ones (numeracy and experience‐based knowledge) and two noncognitive ones (negative emotions about financial decisions). First, we examined how age was related to the four financial decision‐making measures and the four individual‐differences characteristics. Older age was correlated to better scores on each of the four financial decision‐making measures, more experience‐based knowledge, less negative emotions about financial decisions, whereas numeracy and motivation were not significantly correlated with age. Second, we found that considering both the two cognitive and the two noncognitive individual‐differences characteristics increased predictions of financial decision making, as compared with considering either alone. Third, we examined how these four individual‐differences characteristics contributed to age differences in financial decision making. Older adults' higher levels of experience‐based knowledge and lower levels of negative emotions seemed to especially benefit their financial decision making. We discuss implications for theories on aging and decision making, as well as for interventions targeting financial decisions.

Hurdle models of repayment behaviour in personal loan contracts

This paper proposes a hurdle model of repayment behaviour in loans with fixed instalments. Using information on previous and current contracts, the approach yields a model of customer behaviour, useful, for example, in assessing the impact of determinants of default, a natural concern for credit and behavioural scoring. Under plausible assumptions, a debtor in each period faces a number of missed payments, which depends on his previous repayment decisions; meanwhile, as most debtors are expected to meet financial obligations, the number of missed payments is bound to display excess zeros, with reference to a single-part law. Each sequence of missed payments is modelled by using the binomial thinning, a conceptual tool that allows for dependence between integers by defining the support of consecutive counts. Under suitable assumptions on heterogeneity, the model can be produced under a random effects approach, leading to a two-part panel data model, estimable by quasi-maximum likelihood. The proposed approach is illustrated using a panel data set on personal loans granted by a Portuguese bank.

Exposure to intimate partner violence and repayment of microcredit: Evidence from field experiments in Bangladesh

Abstract This paper investigates the impact of intimate partner violence on poor women's repayment behavior in microcredit. In a laboratory-based field experiment, we extended collateral-free small loans to 485 currently married women in rural Bangladesh and observed their repayment decisions over multiple loan cycles. In a post-experiment survey, we asked subjects about their experience of spousal violence. We find that women who experienced physical or sexual violence in the last 12 months are more likely to strategically default on their loans relative to those who did not experience such violence. We conducted several robustness tests, and the results suggest that the negative correlation between victimization and loan repayment rates is unlikely to be explained by selection into victimization, non-random underreporting of violence, or the subjects’ attitude toward risk.

Firmss Strategic Choice of Loan Delinquencies

I analyze the repayment decisions of firms with multiple loans that, for liquidity constraints or strategic reasons, stop making payments in some but not all their loans. Using a sample of commercial loans from Colombia over the period 2002:03-2012:06, I find that firms are less likely to stop making payments on loans granted by banks with which they have long relationships and by banks with which they have a clean repayment history. These results suggest that firms are concerned with losing the benefits gained through the relationship. I also find that firms are more likely to stop making payments on loans from foreign banks when compared to domestic banks, and equally on loans from state owned banks when compared to private banks. This suggests that the ability and willingness of the bank to punish the firm for misbehaving play an important role in a firm’s decision. Overall, the results suggest that firms assess their delinquency choices based on their perceived ability to obtain new loans in the future.

Determinants of Mortgage Default and Consumer Credit Use: The Effects of Foreclosure Laws and Foreclosure Delays

The mortgage default decision is part of a complex household credit management problem. We examine how factors affecting mortgage default spill over to other credit markets. As home equity turns negative, homeowners default on mortgages and home equity lines of credit at higher rates, whereas they prioritize repaying credit cards and auto loans. Larger unused credit card limits intensify the preservation of credit cards over housing debt. Although mortgage nonrecourse statutes increase default on all types of housing debt, they reduce credit card defaults. Foreclosure delays increase default rates for housing and nonhousing debts. Our analysis highlights the interconnectedness of debt repayment decisions.

Consumers’ credit card repayment decisions: The role of higher anchors and future repayment concern

We investigated two aspects of credit card repayment decisions: the extent to which the anchoring effect of minimum repayment information may be mitigated by information on alternative anchors, specifically repayments that would repay the balance in two years (Study 1) or nine months (Study 2); and the role of future repayment concern. In two experiments, three realistic credit card statements were presented with different outstanding balances. Participants, who were randomly allocated to one of four information conditions depending on supplementary information provided on the statements, stated how much they would repay that month. They were then asked about concerns they would have about repayment difficulties if they had a fixed consumer loan over three years. In Study 1 the alternative two-year repayment anchor had a negative effect on percent repayment, whereas in Study 2 the nine-month repayment anchor had a significant positive effect, especially for those with higher future repayment concern. Also, in both studies, future repayment concern had a direct inverse effect on repayment decisions which partially mediated the effect of disposable income. It is concluded that the addition to credit card statements of a table of cost and duration information for a range of repayment amounts may usefully support repayment decisions.

Sovereign default, enforcement and the private cost of capital

This paper develops a signaling model for a small open economy in which the government's sovereign debt repayment decision gives lenders new information regarding the state's capacity to enforce contracts. Contract enforcement affects the expected repayment of private loans. Therefore, if lenders receive negative information from the sovereign default about the state's capacity to enforce contracts, they worsen the financial conditions offered to local firms, triggering a sharp reduction in credit and investment. The key contribution of this paper is to rationalize the worsened private-sector financial conditions observed after default episodes by modeling the price effect of the informational channel.

Promise keeping, relational closeness, and identifiability: An experimental investigation in China

We experimentally investigate some key features of internet peer-to-peer (P2P) lending: the borrower specifies the amount of money required and makes a contingent promise about the value of the generally higher repayment prior to the investor's decision to lend the required sum or not. We examine the role played by two factors related to traditional Chinese culture and ethics: whether (i) guanxi, relational closeness between the actors and (ii) the ability of the actors to observe each other's identity after the repayment decision (identifiability or mianzi concerns) affect the borrowers' decisions to make the promised repayments and ultimately the consequent aggregate realized social benefits. Using a two-by-two factorial design, we conduct four experimental treatments in China and also perform the identifiability treatment in New Zealand as a cultural control. We find that in China both manipulations were positively and significantly related to the probability of a repayment promise being kept. Moreover, these two factors were substitutes for each other. In New Zealand, there was no significant identifiability effect on promise keeping. Over time, relational closeness and identifiability both led investors in China to accept more proposals, resulting in more investment and the creation of greater social surplus.

Understanding Federal Student Loan Repayment

The purpose of this study was to explain the federal student loan repayment process. Individuals with a college degree earn more over their lifetime than those without a college degree. However, the price of a college education has increased substantially and 69% of college graduates in 2012 had student loans to repay. There are eight federal repayment plans that may lead to confusion for borrowers. Education is needed to assist borrowers in making informed repayment decisions. Educators at postsecondary institutions have an opportunity to provide education to students.

Determinants of Mortgage Default and Consumer Credit Use: The Effects of Foreclosure Laws and Foreclosure Delays

The mortgage default decision is part of a complex household credit management problem. We examine how factors affecting mortgage default spill over to other credit markets. As home equity turns negative, homeowners default on mortgages and HELOCs at higher rates, whereas they prioritize repaying credit cards and auto loans. Larger unused credit card limits intensify the preservation of credit cards over housing debt. Although mortgage non-recourse statutes increase default on all types of housing debt, they reduce credit card defaults. Foreclosure delays increase default rates for both housing and non-housing debts. Our analysis highlights the interconnectedness of debt repayment decisions.

When Motivation is against Debtors' Best Interest: The Illusion of Goal Progress in Credit Card Debt Repayment

The authors explore the illusion of goal progress by consumers who own multiple credit cards and pay off their debt balances to facilitate the achievement of their subgoal rather than the superordinate goal of being debt-free. The first experiment shows that debtors use their savings toward the credit card debt they can pay off entirely or substantially, even if it is associated with the smallest balance and the lowest annual percentage rate rather than toward the debt with the highest annual percentage rate. The second experiment reveals that when the income available to pay down the debt is in the form of effortless money (i.e., windfall or reward money) as opposed to hard-earned savings, the tendency to allocate money toward the smallest credit card debt is exacerbated. However, people tend to pay their debt more rationally when the number of debt accounts increases. Finally, the third experiment shows that credit card debt repayment decisions depend on the nature of the debt (hedonic vs. utilitarian) and the timing of consumption benefits (past vs. future). The article concludes with a discussion of managerial and public policy implications.

Minimum Payment Warnings and Information Disclosure Effects on Consumer Debt Repayment Decisions

Public policy makers encourage lenders to disclose loan cost information as a way of enabling borrowers to make more-informed debt repayment decisions. For example, current regulation requires credit card lenders to include a “minimum payment warning” on borrowers' monthly statements, with the goal of encouraging borrowers to make larger monthly repayments each month and, consequently, decrease their debt levels. This research examines the effect of disclosing such information about future interest costs and time to pay off debt on consumers' repayment decisions. The results indicate that disclosing information about the effects of repaying the minimum has little impact on repayment decisions. However, disclosing information about the effect of choosing an alternative course of action (i.e., a larger repayment amount) yielded a robust effect on repayment decisions. The findings suggest that cost information increases repayment amount for some borrowers, whereas time information may decrease repayment for others, especially those with little knowledge of interest compounding. This research provides some initial evidence of the impact of the CARD Act as well as that of similar regulations in Australia and Canada.

Do Non‐Enforceable Contracts Matter? Evidence from an International Lab Experiment

Many verifiable contracts are impossible or difficult to enforce. This applies to contracts among family and friends, contracts regulating market transactions, and sovereign debt contracts. Do such non‐enforceable contracts matter? We use a version of the trust game with participants from Norway and Tanzania to study repayment decisions in the presence of non‐enforceable loan contracts. Our main finding is that the specific content of the contract has no effect on loan repayment. Rather, the borrowers seem to be motivated by other moral motives, which contributes to explaining why they partly fulfill non‐enforceable contracts. We also show that some borrowers violate the axiom of first‐order stochastic dominance when rejecting loan offers. This seems partly to be due to negative reciprocity, but may also reflect that there are individuals who have a preference for not accepting something referred to as a “loan.”

Determinants of repayment performance of group lending in China

PurposeThe purpose of this paper aims to explore how borrower and group‐level characteristics affect repayment decisions of group borrowers by highlighting the case of rural credit cooperatives (RCCs) in Guizhou province in Southwest China.Design/methodology/approachThe Logit model was applied to test the determinants of repayment performance of RCCs' group lending. The authors used the survey data of 245 farm households in Guizhou province, collected in 2008.FindingsThe empirical results indicate that there is a serious mismatch between joint liability mechanisms and the social and economic conditions in rural China. Mechanisms such as threatening to withhold defaulters' future loans from RCCs failed to work. In addition, higher household incomes also did not improve repayment performance. However, factors such as a higher degree of acquaintanceship in a group, migrant income, and employment in government agencies, positively improved the chances of repayment.Practical implicationsGroup lending is more suitable for poorer areas with few opportunities for migration and limited access to finance. In addition, constructing the trustworthy relationship between micro‐lenders and customers and designing diverse and flexible financial services to meet heterogeneous demands are equally important.Originality/valueThis paper is an attempt to empirically explore the determinants of repayment performance in group lending programs in China. The results provide meaningful policy implications for the government and rural financial institutions.

Misclassification of the dependent variable in a debt–repayment behavior context

Abstract This paper estimates a model of the household debt–repayment decision that accounts for the possibility of misclassification of self-reported debt–repayment status. It likewise estimates the extent of misclassification in a sample of data from different European countries. The evidence suggests that many households that are in arrears do not report this condition, so that the true level of arrears is, on average, 24% higher than that observed in our data. Furthermore, the effects on the incidence of arrears of adverse income and expense shocks are substantially greater than those predicted by estimators that ignore the possibility of misclassification.

Credit repayment decisions

Purpose – Information concerning the long‐term consequences of credit repayment decisions is often not available for flexible credit facilities such as credit cards. The purpose of this paper is to investigate the role of such information in repayment decisions. A dual mental accounting model of money management predicted that repayments would be influenced by both total cost and loan duration information. Experiment 2 also investigated the role of key economic and psychological factors, including some related to a risk defusing operator model of risk management.Design/methodology/approach – In two questionnaire‐based experiments bank customers (n=241; 300) were presented with credit card and remortgage repayment scenarios. In both studies, total cost and loan duration information were varied in a 2×2 randomised‐groups factorial design.Findings – In both studies, analysis of covariance showed that information on the long‐term consequences of repayment decisions lead to significantly higher levels of repay...