Imagine living in a home for decades and then someone, perhaps an armed law enforcement officer, shows up and removes you and your belongings, often facing an uncertain future. Foreclosure of one’s home is right up there among life’s most stressful events.
Not surprisingly, foreclosures have been associated with an increased incidence of major depression, even after controlling for other financial stressors. Foreclosures increase and decrease in tandem with the state of the economy, as shown in the graph below:
Fortunately, at the moment, the number of foreclosures in the U.S. has been declining consistently and is now down to the pre-financial crisis level.
But the number is still nowhere near zero.
Clearly, the economy is not the only factor in causing foreclosures. Sometimes people cease to be able to afford their homes, even when economic times are good. One factor that contributes to foreclosures is that borrowers may enter into mortgage contracts that are unexpectedly risky or contain provisions that make a mortgage suddenly unaffordable.
Why would borrowers accept such risky or bad deals?
One obvious answer is that they are not made aware of the consequences of their choices when signing up to a mortgage. In recognition of this problem, the U.S. federal government has increasingly regulated the mortgage industry, with a particular emphasis on mandating the disclosure of loan terms when an application is made. For example, the Truth in Lending Act (also known as TILA), passed in 1968, required lenders to disclose certain key economic parameters to customers. This disclosure is usually achieved via a form that borrowers have to read.
The figure below shows a snapshot of a TILA-type disclosure form, and the full thing can be found here.
There is a 67-page manual that goes along with the disclosure form, which interested readers can peruse here.
However, this disclosure-based regulation largely failed to protect consumers. Consumers failed to shop around for better deals, and they continued to have difficulty understanding the implications of variable interest rates. In response, the design of the disclosure forms has been continually improved, with the federal government producing empirical results showing that comprehension increased when the disclosure forms were revised and improved.
There is, however, another weak link in the chain from government-mandated disclosure to adequately-informed consumers. This involves the behaviour of the lender or mortgage broker who is typically present when consumers are processing the disclosure forms. (Which has been timed to require 3 hours for a highly financially literate person).
In a recent article in the Psychonomic Society’s new open access journal Cognitive Research: Principles and Implications, Jessica Choplin and Debra Pogrund Stark reviewed the literature on government-mandated home-loan disclosures and how they can be undermined by the verbal behaviour of irresponsible lenders.
To put this work into context, here is how the United States Court of Appeals for the 9th Circuit described irresponsible lenders’ practice:
“Loan officers would employ a standardized sales presentation to persuade borrowers to take out loans with high interest rates and hidden high origination fees or “points” and other “junk” fees, of which the borrowers were largely unaware. The key to the fraud was that loan officers would point to the “amount financed” and represent it as the “loan amount,” disregarding other charges that increased the total amount borne by the borrowers.”
This is perhaps a particularly egregious example, but given the complexity of the information provided and the time demands it places on consumers, it is easy to see how verbal behaviors by lenders might undercut the intentions of full disclosure. By simply leading consumers through the disclosure forms, lenders might point out the monthly payments but skip over the annual interest rate, which might be higher than what consumers expect.
In addition to this fairly obvious misdirection, Choplin and Stark identify a number of well-established cognitive processes that might further assist lenders in misleading consumers. Here is a subset that I found particularly intriguing.
Gricean maxims. One of the basic norms of conversation that we all expect others to conform to is the norm of quantity. In conversations, we assume that conversational contributions will be as informative as is required given the circumstances. If there is a bush fire approaching, I expect my neighbour to tell me about that rather than last night’s cricket game. If irresponsible lenders violate this expectation, borrowers may feel that they have been adequately informed not based on what they have heard, but based on what they expected to be told.
Confirmatory reading. People seek confirmatory information, even when it would be far more diagnostic to look for information that disconfirms one’s tentative hypothesis. In the disclosure context, people are therefore likely to look only for information that confirms what they were told rather than disconfirming instances. So if an irresponsible lender mentions a low interest rate that only holds for the first year, but neglects to inform borrowers of the higher rate after that, then consumers may scan the documents for the low interest rate rather than any possibly disconfirming information about subsequent changes to that rate. Indeed, there is evidence that many borrowers who are presented with a floating rate loan do not know that their mortgage might lead to a doubling of interest rate within a few years.
Part set cueing effects. Even if lenders are trying to be helpful by reminding consumers what to look for, this can have adverse consequences owing to a phenomenon known as part-set cueing. The basic part-set cueing phenomenon refers to the fact that if a subset of items is provided as retrieval cues, then recall of the remaining items is—counterintuitively—impaired. In the context of disclosure, this means that if a lender reminds consumers to look at a few items (e.g., interest rate, prepayment charges), the consumers may have difficulty remembering to look at the remaining items. Indeed, an experiment in Choplin and Stark’s lab provided evidence for this through analysis of eye movements: participants were less likely to remember to look at items that the experimenter had not mentioned before (compared to a control condition in which no items were mentioned).
Explaining away bad terms. Suppose you are lining up at a photocopier, and someone cuts into line with the explanation “I am in a rush to get to class”. Many people are happy with that explanation and consent to the person cutting in. Intriguingly, people also consent when the person cutting into the line provides the explanation “I need to make some copies.” It appears that people do not insist on an authentic explanation in many circumstances: the magic word “because” seems to do the trick even if it is followed by nothing terribly meaningful. An experiment in Choplin and Stark’s lab provided evidence that this also works in the context of forms: they found that providing a senseless explanation (“this is just the way the form was drafted”) allayed people’s concerns and they signed the form as requested. This phenomenon obviously opens avenues for irresponsible lenders to explain away aspects of a loan that may trigger borrowers concerns.
What does all this add up to?
Choplin and Stark suggest that:
“reliance on disclosure documents alone to protect consumers will inevitably be unsuccessful, except for very sophisticated home loan consumers. Verbal behaviors by salespeople—sweet nothings—such as violating conversational norms, introducing confirmation biases, and talking to consumers can direct consumers’ attention away from critical information as they review disclosure forms towards misleading information. Even extremely well-designed documents leave consumers vulnerable to such misleading sales strategies.”
Sweet nothings are often neither sweet nor nothings.
Psychonomics article highlighted in this post:
Choplin, J. M., & Stark, D. P. (2019). Whispering sweet nothings: A review of verbal behaviors that undermine the effectiveness of government-mandated home-loan disclosures. Cognitive Research: Principles and Implications, 4, 6. DOI: 10.1186/s41235-019-0154-7.
