Online loan marketplaces change consumer lending

The hardest part of shopping for a loan used to be comparing lenders. Finding out who would lend to you — and on what terms — meant approaching banks one by one.

The genesis of digital lending platforms changed all that in the mid-2000s, making it possible for borrowers to compare personalized offers from dozens of loan providers in just minutes.

But new research by Professor Camelia Kuhnen at UNC Kenan-Flagler Business School suggests removing one barrier exposes another: The search for better offers often requires more applications, with each application making the borrower appear riskier to the next lender and reducing their chances of securing credit.

“Digital lending platforms have fundamentally changed the economics of searching for credit,” Kuhnen says. “Search costs are no longer the main force shaping behavior. Instead, borrowers face cognitive costs from evaluating so many offers and reputational costs as lenders observe repeated applications.”

The finding is based on one of the largest studies of digital lending to date, drawing on more than 730,000 loan applications, 750,000 loan offers and over 200,000 borrowers using Finland’s biggest online loan marketplace. She and Alex Günsberg of the Hanken School of Economics share their findings in their working paper “Learning How to Borrow in a Fintech World: Consumer Behavior When Search Costs Are (Near) Zero.”

Their research suggests the challenge for fintech companies is reducing the hidden costs of search itself: weighing dozens of offers without signaling risk to lenders.

Borrowers rarely settle for the first offer: They rejected 47% of the loan offers they received and submitted an average of 3.6 applications before making a final choice. But they stopped well before finding the best possible deal because the costs of comparing more offers and submitting more applications eventually outweighed the gains.

The findings also show why searching remains worthwhile. Identical borrowers often received very different loan offers. Around a quarter of the variation in interest rates came down simply to which lender made the offer — suggesting the first offer was rarely the best one.

The challenge, then, is not whether to search, but how to search.

The researchers then asked, could digital lending platforms help borrowers make better decisions? This turned out to be a far tougher challenge than making the search for loans easier.

The study found that gentle “nudges”, such as spotlighting the best loan offer, helped borrowers make sense of the kaleidoscope of options. Yet stronger nudges that effectively selected a loan for them backfired.

On Finland’s largest digital loan marketplace, more than half of borrowers (52%) chose to use the “autoselect” feature, which picks out the best loan offer. Yet receiving the mightier nudge cut the likelihood of taking out a loan by 2.04 percentage points.

“Good platforms should simplify decisions without taking those decisions away from borrowers,” Kuhnen says.

Even so, there was one problem no platform could solve: how lenders viewed repeated loan applications. The study found that searching for a better loan can make borrowers look like a worse bet. The more borrowers searched, the more lenders questioned why, even when their underlying creditworthiness had not changed.

For an AA-rated borrower, the odds of receiving a loan offer from the same lender fell from 18% on a first application to just 5% on a repeat application. Those repeat applicants also paid around 0.7 percentage points more in interest, even after accounting for differences in credit risk.

The findings suggest successive applications cast a reputational signal that spans beyond a borrower’s formal credit record. Lenders infer that repeat applicants are riskier, making them less likely to receive a loan and more likely to pay higher interest rates.

“Every time you apply for a loan or search, that might be reported to a credit bureau, depending on the country,” says Kuhnen. “So, the reputational cost can be much higher and lenders could see you as a worse-quality borrower.”

The message is not that borrowers should stop shopping around. Far from it.

Shopping around can pay, but the challenge is knowing when to stop.

“There are two types of consumers in this marketplace,” Kuhnen says. “People with the best credit ratings seem satisfied pretty quickly. If they receive a good offer, they take it and leave. People with worse credit ratings search many more times and are penalized for it.”

Fintech has all but eliminated the cost of searching for a loan. The challenge now is making sure the search itself doesn’t become the cost.