High-Cost Debt and Perceived Creditworthiness: Evidence from the U.K.
68 Pages Posted: 20 Jun 2016 Last revised: 27 Jun 2018
Date Written: June 2018
When taking up high-cost debt signals poor credit risk to lenders, consumers trade off alleviating financing constraints today with exacerbating them in the future. Using data from a high-cost lender in the U.K., we document the trade-off by testing a unique cross-sectional prediction of this mechanism: high-cost credit use will have a larger negative impact on financial health for borrowers with the highest initial perceived creditworthiness. We employ a research design that combines quasi-random assignment of loan officers and a discontinuity in application approvals to characterize the heterogeneity of the effect of high-cost credit use. We find that high-cost credit use affects a borrower’s credit scores and future access to credit, but only if the borrower’s initial credit score is relatively high. In contrast, high-cost credit use does not significantly affect the ex post riskiness of borrowers with initially high credit scores. The results suggest that high-cost borrowing may leave a self-reinforcing stigma of poor credit risk.
Keywords: Consumer finance, credit scores, credit supply
JEL Classification: D14, G21, D91
Suggested Citation: Suggested Citation