High-cost Debt and Borrower Reputation: Evidence From the United Kingdom
AbstractWhen taking up high-cost debt signals poor credit risk to lenders, consumers trade off
alleviating financing constraints today with exacerbating them in the future. Using data
from a high-cost lender in the U.K., we document this trade-off by exploiting random
application assignment to loan officers, which measures the effect of loan take-up for
the average applicant, and a regression discontinuity design, which measures the effect
of take-up for the marginal applicant. For the average applicant, taking up a high-cost
loan causes an immediate and permanent decline on the credit score, and leads to more
default and credit rationing by standard lenders in the future. In contrast, the marginal
applicant—whose credit score is not affected—is not more likely to default and does not
experience further credit rationing after take-up. Thus, high cost credit has a negative
impact on future financial health when it affects borrower reputation, but not otherwise.
The evidence suggests that high-cost borrowing may leave a self-reinforcing stigma of
poor credit risk.