2014 Conference

The increasing pervasiveness of high-cost alternative financial services (AFS) such as payday loans, rent-to-own financing, pawn shops, auto title loans, and refund-anticipation loans has captured the attention of policy makers, consumer educators, and financial counselors. Using data from the 2009 and 2012 waves of the National Financial Capability Survey (NFCS), this paper investigates AFS borrowing behaviors through the lens of bounded rationality. Foremost, this research seeks to isolate less than optimal AFS borrowing decisions to better understand the roles of actual (objective) and perceived (subjective) financial knowledge in the consumer decision-making process. This is accomplished through repeated testing of isolated samples of individuals with characteristics that make them less likely to objectively need such products. Consistent results indicate that individuals with higher objective financial knowledge are significantly less likely to utilize AFS instruments. Furthermore, results indicate that individuals with low actual financial knowledge scores and high self-assessed financial knowledge are most prone to making AFS borrowing decisions. These results indicate that borrowers are limited by bounded rationality, making less optimal financing decisions holding all else equal.