High-Cost Debt and Borrower Reputation: Evidence from the U.K
MetadataShow full item record
When taking up high-cost debt signals poor credit risk to lenders, consumers must trade off alleviating credit constraints today with exacerbating them in the future. We document this trade-off by exploiting the random assignment of applicants to loan officers with different propensities to approve otherwise identical loans by a high cost lender in the U.K. For the average applicant, taking up a high-cost loan has a large, immediate, and permanent impact on the credit score. Take-up also leads to more default and credit rationing by standard lenders. In contrast, borrowers whose credit score is not affected by take-up — because they already have low credit scores at the time of application — are no more likely to default and experience no further credit rationing. Thus, high cost credit has a negative impact on future financial health when it affects borrower reputation, but not otherwise. The evidence suggests that high-cost borrowing may leave a self-reinforcing stigma of poor credit risk.
- R & P Seminar