This article describes the implications of findings from research in cognitive and social psychology for consumer protection policy. The real-world implication of these findings is that psychological phenomena such as the influence of verbal information on visual search, conversational norms, confirmation biases, dual tasks, part-set cuing memory effects, and the effects of explanations on compliance undermine the effectiveness of disclosures to protect consumers. Research on these psychological phenomena suggests alternative policy prescriptions that policymakers should consider.
Home loans are the largest financial transaction consumers enter into (Bureau of Labor Statistics, 2017), and—due to the variety of features they can embody—they are also very complicated to parse (Choplin, Stark, & Mikels, 2013). Poor decision making when entering into such transactions can have dire consequences for the individuals who enter into them, including high rates of default and foreclosures (Federal Trade Commission, 2000). These dire consequences were seen most profoundly during the real estate recession starting in 2008 and its aftermath (Herron, 2013). Poor individual decisions on home loans can even have a strong negative impact on entire communities (Goodwin, 2016) and the general economy (Stiglitz, 2010). Due to the importance of making prudent home loan decisions and to protect consumers from overpriced and unaffordable home loans (two examples of “predatory home loans”), the federal government has increasingly regulated this industry (Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010; henceforth Dodd-Frank; Real Estate Settlement Procedures Act, 1974, henceforth RESPA; Truth In Lending Act, 1968, henceforth TILA).
The federal government’s primary strategy in regulating this industry, however, has been a policy of mandating the disclosure of loan terms at the time the loan application is made and just before the funding of the loan. Prior to 2015, home loan consumers received the TILA and HUD-1 (Housing and Urban Development) RESPA forms to disclose the offered loan terms. Since 2015, they have received the Consumer Financial Protection Bureau’s (CFPB) Loan Estimate and Closing Disclosure forms. There are many problems with relying on disclosures alone to protect consumers. We have reviewed some of the cognitive and social psychological reasons why this regulatory approach is ineffective elsewhere, including problems such as consumers’ inability to process user-unfriendly features of disclosure forms, lack of contractual schemas, biases in assessing risk such as reliance on availability heuristics, reason-based decision making, biases in attribute evaluation and estimation, sunk cost and endowment effects, and temporal and uncertainty discounting (Stark & Choplin, 2009, 2010). This review article focuses on the related topic of how verbal behaviors on the part of salespeople such as mortgage brokers and lenders can undermine the effectiveness of disclosures, making the policy of relying on disclosures alone to protect consumers unwise.
The disclosure approach to consumer protection was first adopted during the late 1960s and early 1970s due to concerns that homeowners lacked the information necessary to make wise home loan decisions. Thus, Congress enacted TILA in 1968 and RESPA in 1974, which required lenders to disclose to consumers who apply for federally related home mortgage loans certain key economic loan terms. Congress presumed that borrowers would carefully read the disclosures, understand the basic terms of the proposed loan, and thereby be empowered to make wise decisions on whether to accept or reject an offered home loan. The assumption was that once consumers received this information, they would be able to shop for a loan that best suited their needs and goals. They would naturally select the best available loan for which they qualified; and since the assumption was that consumers understood the information presented in these disclosures, they would be granting their informed consent to the terms of any loan they entered. Requiring disclosure as a means to protect consumers from entering into problematic home loans was viewed as preferable to directly regulating the terms of these loans (such as requiring a maximum interest rate, maximum fees/costs, or imposing statutory maximum limits on the amount of mortgage debt based upon the borrower’s income) based upon the notion that under a free market with informed decision makers the parties can best maximize their utility and exercise their personal autonomy.
The policy of using disclosures failed to protect consumers for numerous reasons. Some of those reasons involved the cognitive and social psychology of consumers (the focus of this review), but there were also problematic changes in the industry. Over the following decades, home mortgage loans became increasingly complex and susceptible to abusive practices by lenders and mortgage brokers, which contributed to the mortgage crisis in the late 2000s (Carrozzo, 2005; Korngold & Goldstein, 2015; Woodward, 2003). Thus, disclosure forms proved not to be very helpful in adequately highlighting and informing many home loan consumers on the terms of their proposed loan, especially any problematic terms, and whether it would be wise to enter into it. For example, many consumers had difficulty identifying when loans had adjustable interest rates on the TILA and HUD-1 forms that were used prior to 2010 (Stark, Choplin, & LeBoeuf, 2013). Nor did these disclosure forms lead to consumers shopping for a better home loan as desired (Renuart & Thompson, 2008). In response, various arms of the federal government have tried to revise them to be more “user-friendly” and useful to borrowers. The Department of Housing and Urban Development created a revised HUD-1 RESPA disclosure form in 2008 that became effective in 2010 and which changed the form in order to, among other things, better highlight the adjustable rate features that a loan may have. After the great real estate recession, Congress created the Consumer Financial Protection Bureau to improve the disclosures further (Dodd-Frank, Section 1032[f]), and to outlaw some of the most harmful loan products (Dodd-Frank, Sections 1402 and 1403). But the policy emphasis continues to be that of mandatory home loan disclosures as the primary means to prevent home loan borrowers from entering into loans that are overpriced (higher in interest rates, fees and costs than they qualify for), unaffordable (based on their income), or risky (such as containing interest rates that can dramatically rise during the term of the loan). The Consumer Financial Protection Bureau (CFPB) produced its own home loan disclosure forms which have been in use since 2015. The CFPB forms combined two separate forms (the HUD-1 and the TILA) into one form when consumers receive an offer (Loan Estimate) and another form that consumers receive at closing (Closing Disclosure) and revised how the APR (annual percentage rate) is disclosed so that it is less conspicuous.
The effectiveness of disclosure forms has been the subject of some empirical testing. For example, the Federal Trade Commission (FTC) proposals for how to revise the TILA and HUD-1 RESPA disclosure forms were tested and consumers were found to answer more questions accurately after reviewing the FTC’s proposed disclosure form than after reviewing the TILA and HUD-1 disclosure forms (Lacko & Pappalardo, 2007). Likewise, the change in how the APR is disclosed under on the CFPB loan estimate form from the dual HUD-1 and TILA disclosures that were previously used was based on consumer testing reflecting that consumers were confused by APR and could not define it correctly (Kleimann Communication Group, Inc., 2009; Stark et al., 2013). This testing, however, was mostly concerned with the physical layout of the disclosure forms, the ability of consumers to comprehend what was being disclosed, and the ability of consumers to identify the lower cost loan when two different loans were presented in disclosure documents. The problems with disclosures are not limited to issues involving the physical layout of disclosure forms, but also include numerous issues in consumer psychology. Active research in judgment and decision making and related areas of cognitive and social psychology provides many insights into barriers that undermine the effectiveness of home loan disclosures (Barr, Mullainathan, & Shafir, 2008; Stark & Choplin, 2009, 2010; Willis, 2006). These fields of study can also provide insights into how verbal behaviors of the part of salespeople—their whispered sweet nothings—can undermine the effectiveness of the disclosure approach to consumer protection.
The primary psychological reason why disclosures are less effective than Congress originally hoped and also why salespeople’s sweet nothings can undermine their effectiveness is that the sheer volume of information consumers need to absorb is excessive (Barr et al., 2008). For example, in one case the court noted that it took the consumer two hours and forty-five minutes to read the car purchase and finance documents (Castellana v. Conyers Toyota, 1991). In another case, the court noted the problem of consumers being presented with “an incomprehensible number of additional forms to sign at closing” in a home loan transaction (In re: T.V. Dukes, 1982). The number of issues that mortgage consumers must consider and the complexity of those issues is inordinately large, such that home loan mortgage decisions are almost certainly among the most complex decisions that consumers will face in their lifetime (Choplin et al., 2013). There are cognitive limitations on what people can remember (Miller, 1956; Ratcliff, Clark, & Shiffrin, 1990; Roediger III, 1973) and consider when making decisions (Lussier & Olshavsky, 1979). Dual process models provide a valuable way to think about these limitations (e.g., Chaiken’s heuristic-systemic model, Chaiken & Ledgerwood, 2011; Kahneman, 2011; Petty and Cacioppo’s Elaboration Likelihood Model, Petty & Cacioppo, 1986). A number of researchers have even proposed that these models should serve as a general theoretical framework to think about consumers’ vulnerabilities to fraud and scams (Langenderfer & Shimp, 2001; Lea, Fischer, & Evans, 2009; Rusch, 1999; Whitty, 2013), which would include their vulnerabilities to predatory home loans.
Dual process models propose two different information-processing paths for making decisions (Petty, 1986). Under some situations, consumers are able to take the central processing route (Petty & Cacioppo, 1986; called System 2 by Kahneman, 2011) and carefully think through the options given all of the available information, but to do so they need to be highly motivated and able to process an extraordinary amount of information (Petty & Cacioppo, 1986). Mortgage consumers are highly motivated because the mortgage decision is one of the largest financial decisions that they will make in their lives. However, the decision-making process involves so many unfamiliar concepts (e.g., APR; Kleimann Communication Group, Inc., 2009; Renuart & Thompson, 2008), unknown contingencies (e.g., how long they may hold the loan, future interest rates, and the total cost of housing including estimating real estate taxes and home insurance and repair costs; Choplin et al., 2013), and relational complexity (e.g., deciding between a loan with a low interest rate and high fees or a loan with a high interest rate and low fees; Stark et al., 2013) that it is also among the most complex decisions that they will make in their lives. Thus, they will often be unable to use central, System 2 processing (Choplin et al., 2013).
When consumers are unable to process information as thoroughly as they need or as quickly as they need using System 2, they rely upon System 1, which utilizes shortcuts and heuristics to make decisions (Chaiken & Ledgerwood, 2011) and they engage in more superficial, peripheral processing (Kahneman, 2011; Petty & Cacioppo, 1986). Furthermore, predatory mortgage brokers and lenders can likely encourage their customers to use this System 1 processing by providing credibility cues and promises of homeownership as a reward, as research has found these factors to be very effective at invoking System 1 processing (Fischer, Lea, & Evans, 2013; Langenderfer & Shimp, 2001; Lea et al., 2009; Rusch, 1999; the effects of these credibility cues and rewards are well-established in other domains, but future research should investigate how they operate in the context of home loans). Thus, despite the advantages of using System 2 processing and despite having higher motivation to engage in more complex, systemic processing for mortgage decisions than most of the other decisions that they make, mortgage consumers will too often be using peripheral, System 1, processing to make home mortgage decisions.
Because consumers are too often using peripheral, System 1 processing even when making decisions as important as choosing a home mortgage, they rely on heuristics (Willis, 2006) and other decision-making shortcuts (Stark & Choplin, 2010; see Chaiken & Ledgerwood, 2011 and Kahneman, 2011 for theoretical approaches to this type of processing) and, thus, fail to use the information presented in the disclosure form well. A long line of research on persuasion has demonstrated that people are more likely to rely upon authority and other credibility cues as a shortcut when they lack the capacity to process information slowly and carefully (Kiesler & Mathog, 1968; Petty & Cacioppo, 1986). Such credibility cues might include whispered sweet nothings, such as statements expressing benevolence (that the salesperson is on the customer’s side) and statements expressing expertise early in their interaction (Arndt, Evans, Landry, Mady, & Pongpatipat, 2014) and these cues could cause them to take an authoritative salesperson’s word and fail to carefully scrutinize the disclosure form (this phenomenon is well-supported in other domains, but future research should test how it operates in the context of home loans). Likewise, consumers who recognize the mortgage lender perhaps from seeing or hearing their advertisements might use the recognition heuristic as a shortcut (Goldstein and Gigerenzer, 2002) and go with the lender they recognize and, thereby, fail to scrutinize the information presented on the disclosure form (this phenomenon is also well-established in other domains, but future research should test how it operates in the context of home loans).
Alternatively, consumers might look for a justification or reason to choose one option over another, rather than weighing all of the pros and cons of each option (Shafir, Simonson, & Tversky, 1993). This strategy might cause consumers to skim the disclosure form and seize upon one salient attribute, such as the monthly payment, at the expense of all other attributes in making choices, and to fail to read the remainder of the disclosure form (Willis, 2006). Salespeople can likely sway people toward using this type of decision-making by asking for a justification or by raising issues of justifiability (Briley, Morris, & Simonson, 2000) or by using puffery that can serve as a justification (Alba, Marmorstein, & Chattopadhyay, 1992; Simonson & Nowlis, 2000; like the phenomena described above, this phenomenon is well-established in other domains, but future research should also test how it operates in the context of home loans).
One way home loan consumers reduce the amount of information they need to consider is to adopt strategies to reduce the amount of reading or to guide their skimming of contracts and disclosure forms (LeBoeuf, Choplin, & Stark, 2016; Stark et al., 2013; Stark & Choplin, 2009). The sheer volume of information in the disclosure form and other home loan documents also creates a situation wherein non-expert borrowers need to be led through the documents that they are required to sign. Yet, the necessity of being led through these home loan contracts and forms can be problematic and make these borrowers vulnerable to deception as well as—in some unexpected circumstances—innocently causing the borrower to fail to spot or remember an important problematic loan term.
Particularly problematic is the fact that, currently, mortgage brokers and lenders typically lead consumers through disclosure forms. For example, they might point out on the disclosure forms the monthly payment amount and loan amount, but skip over the APR (the interest rate plus fees and most closing costs expressed as an annual percentage rate) if the APR figure is higher than what the borrower is expecting. After highlighting a few of the non-problematic disclosure terms, the mortgage broker or lender then moves on to the next set of loan documents rather than asking the borrower to carefully read over the entire disclosure form. Consumers may still feel that they have “read” the disclosure documents and loan documents because they have had the documents explained to them in this fashion even though they have not really read over the disclosure documents in their entirety as Congress intended.
In Stark and Choplin (2009), 72.7% of participants self-reported that they had read all of the terms of the home loan documents and 21.2% reported that they skimmed the loan documents (6.1% admitted that they did not read any of the loan documents). We are skeptical of the claim made by those 72.7% of participants that they really read all of the documents, however, as it took over three hours for a highly financially literate person to actually read each of the words in these documents (Stark & Choplin, 2009). Although some mortgage brokers and lenders induce borrowers to accept the disclosure documents without any explanations of these documents, most of the time the mortgage broker or lender makes some attempt at explaining these disclosure forms on some level to the consumers. This process can make consumers feel as if they have read the disclosure documents when they really have not done so in their entirety.
In the following sections, we describe three of the problems that consumers face in reviewing home loan disclosure documents and how these problems leave consumers vulnerable to misleading verbal behaviors—sweet nothings—on the part of salespeople when they are led through disclosure documents. These three problems are: (i) consumers do not know where to look when they review disclosure documents; (ii) even if consumers know where to look, they may have difficulties remembering to do so; and (iii) even if consumers discover problematic terms, the terms can often be explained away. Once we have reviewed these problems and the cognitive and social psychological factors that aggravate them, we will discuss possible alternative policy approaches beyond disclosures alone that policymakers should consider.