In the hopes of preventing another crisis like the one that led to the Great Recession six years ago, new Federal regulations go into effect this month requiring that borrowers receive more transparent mortgage disclosure forms, which will spell out loan terms in unprecedented detail.
And while some aspects of the new rules—especially a requirement that gives borrowers more time to review the numbers—could help improve financial decision making, others will likely do little to change home buyers’ behavior. Research by behavioral economists shows that when it comes to keeping people from making financial mistakes, adding more transparency probably won’t help people make better choices .
Contrary to what you might think (and what many regulators would have you believe) “providing people with more information doesn’t help” when it comes to helping people choose a healthier path says Dan Ariely, author of ‘Predictably Irrational’ and professor of behavioral economics at Duke University’s Fuqua School of Business.
In a study published in ‘Health Affairs’ in 2012, Ariely and his former colleague Janet Schwartz tested the effect of calorie labeling in consumption at a Chinese fast-food restaurant. To examine how increased information would impact diners’ behavior, they instructed servers to ask customers if they wanted to reduce the portion size of three “starchy” dishes. Consistently, less than 1/3 of customers took the offer—even if they were provided with a financial incentive—like reduced pricing—for doing so. Calorie labeling “had no measurable impact on ordering behavior,” according to the study. “If anything, the downsizing offer was less effective in changing customers’ ordering patterns with the calorie labeling present,” they wrote.
“Giving people more information about calorie labeling does almost nothing to change their behavior,” Ariely says. The same, he says, is true for money. “In the case of investment and savings, teaching people what’s called financial literacy does very little to change their behavior.”
The reason has to do with how we puzzle through complex issues. There are many variables that are hard to account for when making sound decisions—with food, the body is dynamic and constantly changing. Eating more could cause weight gain one day, but not the next, Ariely explains. (Changes in metabolism, exercise and sleep habits affect how we process meals or snacks.)
With money, the randomness of the stock market, not to mention the difficulty of accurately predicting returns can prove too hard to reason through—even for professionals. As for the costs of compound interest—even if bluntly disclosed in detail in a loan application—it can be difficult to intuit. “Yes, we can compute it, but if I said ‘what’s the difference between an interest rate for 30 years on your mortgage of 3.7% to 3.3%,’” Ariely says. “It looks very small but if you look at the compound interest it’s very high.”
Then there’s our desire for immediate gratification, which tends to trump all else. “In the short term it’s fun to spend to money in the long term it’s not so good—in the short term it’s fun to have donuts and chocolate and in the long term it’s not so good,” Ariely says. In other words, if we really want the cake or the car, or the muffin or the mortgage, reading the fine print won’t stop us. No matter the potential fallout.