Screening on Loan Terms: Evidence from Maturity Choice in Consumer Credit

Asymmetric information between borrowers and lenders may induce inefficiencies in credit markets, lenders can partially mitigate these inefficiencies by using a menu of loans with different rates and contract terms to screen borrowers. Hertzberg et al. (2018) exploit a natural experiment in the largest online consumer lending platform to provide the first evidence that loan terms, in particular maturity choice, can be used to screen borrowers based on their private information. We compare two groups of observationally equivalent borrowers who took identical unsecured 36-month loans; for only one of the groups, a 60-month loan was also available. When a long-maturity option is available, fewer borrowers take the short-term loan, and those who do default less. Additional findings suggest borrowers self-select on private information about their future ability to repay.

The full paper shows here.

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