How loan confusion could be costing you thousands

Pete Lunn spoke about the ESRI's new investigation on Newstalk Breakfast...

How loan confusion could be costing you thousands

Image: Tim Goode / EMPICS Entertainment

ESRI behavioural economist Pete Lunn has said that the market for personal loans "doesn't look like it functions particularly well" and that confusion surrounding borrowing could be costing Irish consumers thousands of euro.

Lunn was speaking on Newstalk Breakfast about the findings of new ESRI report on the matter.

Over the course of a year, experiments were conducted in PRICE Lab and evidence was obtained that consumers find it hard to understand how the length of a loan affects both the size of monthly repayments and the overall amount it costs to borrow, leading to inconsistent choices.

Lunn said:

"If you take a loan for €10,000 over five years, whether you choose the best one on the market or the worst one on the market can make a difference of two or three thousand euros to how much you actually pay in order to borrow that money...

"There's also a fair number of marketing tactics within the market which would suggest that consumers are not necessarily making sound financial decisions.

"If you decide who to take a personal loan with on the basis that they'll approve it in three hours rather than 48, given how much it can cost you to make the wrong choice, that's not really a good way to go about it...

"It turns out the key problem with the personal loan is not just that you need to look for a low interest rate, it's actually how long to take it out for.

"It can make a really big difference to how much you pay in the long-run whether you go for a three-year loan, a four-year loan, or a five-year loan.

"Now obviously the less time you borrow the money for, the higher your monthly repayments will be, because you've got to pay it back more quickly. But the longer you take it for, the more it costs you in total to borrow the money.

"And what we discovered was that consumers had a poor intuitive understanding of this relationship.

"That they couldn't make the trade-off between higher monthly repayments if they went for a shorter loan, or how much it cost them in total when they went for a longer loan...

"Not only were they inconsistent in their choices but we found that we could steer their choices pretty easily in one direction or the other without them realising we were doing it."