Learning from the lab: Designing an auto loan calculator to improve car purchase decision making

Background

Data from the Federal Reserve shows that over four million Americans are more than 90 days late on their car loan payments. This is the highest late-payment rate since the height of the financial crisis. Auto loan delinquencies rose more than any other category in 2016, according to recent data from the American Bankers Association. Meanwhile, the number of auto loans issued per year has grown at a rate of over 60% since 2012.

Despite these statistics, car dealerships do not face stringent regulatory oversight. In 2013, the CFPB issued guidance to curb dealer incentives, but this was repealed by the House of Representatives and is currently off of the CFPB’s top priority list. As an example of the misaligned incentives to dealers, one dealer in Massachusetts was found to have inflated or included unverifiable incomes in 10 out of 11 loan applications.

Key Insights

To better understand the broader context of auto-lending, we conducted field visits with debt collectors, listened to collections calls, and tried to buy used cars at a number of car lots. We found troubling evidence suggesting that many borrowers are being set up for failure.

• Car prices are obscured. In fact, car prices are often not shown and are also often framed and negotiated monthly with no reference to total cost. Any negotiated decreases in monthly cost may actually be offset by increases in interest rate, loan length, and total cost.

• Salespeople use powerful sales tactics. These tactics include anchoring car buyers to high car values, pushing test drives and leveraging the endowment effect to get people to “fall in love” with a car, and pressure sales when a sale looks unlikely or a customer begins to walk away. In other cases, dealers commit outright loan application manipulation.

• Car buyers rarely – if ever – consider the full cost of owning a vehicle when deciding how much they should spend on a car. While buyers base their decision on upfront costs and the car payment, they forget to account for other ongoing costs like insurance, repairs and maintenance, and gas. This true cost of the car can significantly impact their ability to make monthly payments and meet other financial obligations in the future.

Experiment

We developed an auto loan calculator that uses a person’s income and expenses to provide a recommendation for the price of a car that a borrower should buy. The recommendation includes how much people should expect to pay for the various costs of car ownership, like gas, repairs and maintenance, and insurance.

To assess how the calculator changed people’s expectations around purchasing a car, we conducted a between-subjects experiment with 1,500 participants. Each respondent was also randomly assigned to 1 of 3 conditions:

• Cost Reflection where participants were prompted to take 20 seconds to reflect on the costs of owning a car.

• General Reflection where participants were prompted to take 20 seconds to reflect on owning a car generally.

• Control where participants were not asked to reflect on anything.

Within each condition, we had respondents estimate the costs of car ownership both before and after using the auto loan calculator to see how using the calculator changed their perceptions of car ownership.

Results

Interestingly, we found that reflection significantly increased estimates of gas, repairs and maintenance, and insurance even before people went through the auto loan calculator by $5-$6 per cost category (p<0.05). However, the Auto Loan Calculator offset these differences. We believe that both asking people to reflect on the cost and the Auto Loan Calculator increased cost estimates by reminding people that specific costs exist.

Using the auto loan calculator led respondents to increase their cost estimates from $50 to $89, which included increases in the cost of gas, repairs and maintenance, and insurance. In total, the auto loan calculator also reduced estimates on sticker prices people thought they can afford from ~$15,000 to ~$12,500 (17% reduction).

Ideally, car dealerships would post monthly costs at the point of car purchase for car payments as well as expected gas, repairs and maintenance, insurance, and a total monthly car amount. We hope to partner with a credit union or tech platform to understand the impact of the Auto Loan Calculator on decisions at loan origination with a wider audience.