High-Cost Debt and Perceived Creditworthiness: Evidence from the U.K.

68 Pages Posted: 20 Jun 2016 Last revised: 27 Jun 2018

See all articles by Andres Liberman

Andres Liberman

New York University (NYU) - Department of Finance

Daniel Paravisini

London School of Economics & Political Science (LSE)

Vikram Pathania

University of Sussex - Department of Economics

Date Written: June 2018

Abstract

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

Liberman, Andres and Paravisini, Daniel and Pathania, Vikram, High-Cost Debt and Perceived Creditworthiness: Evidence from the U.K. (June 2018). Available at SSRN: https://ssrn.com/abstract=2797383 or http://dx.doi.org/10.2139/ssrn.2797383

Andres Liberman (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

HOME PAGE: http://pages.stern.nyu.edu/~aliberma/

Daniel Paravisini

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Vikram Pathania

University of Sussex - Department of Economics ( email )

Falmer, Brighton BN1 9SL
United Kingdom

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