Under the Hood: CFPB research exposes pricing confusion

A pricing report released last month by the Consumer Financial Protection Bureau revealed that consumers are confused when prices are broken down into multiple parts and tend to pay more for the combination of those products. While the report was meant to imply that junk fees likely impede fair and competitive pricing , the research calls into question the regulatory mandates for lenders and dealers to spell out every individual price component of an auto loan. Revealing research The CFPB report, “Price Complexity in Laboratory Markets,” presents data from several pricing experiments conducted between 2015 and 2019 by the Gettysburg Lab for Experimental Economics . The research centered on pricing complexity and market dynamics. Specifically, the objects for sale in the experiments had either a single, all-in-one price or were split into eight or 16 sub-prices, and the number of sellers varied between two and four. Ultimately, the research revealed that consumers paid more for identical products when prices were broken into parts, and they also made more mistakes in their purchases. In markets with 16 sub-prices versus an all-in-one price, sellers’ total asking prices were 60% higher, and buyers were 15 times more likely to select higher-priced options. Further, when the number of sellers and the number of sub-prices increased, buyer mistakes shot up 300%. Complexity leads to confusion The CFPB reiterates in the report how the use of complex terms and pricing confuses consumers. The agency singled out credit cards, checking and savings accounts, mortgages and auto loans as financial products that entail complex pricing that could confound consumers. With auto loans, interest rates vary based on credit score, loan term, down payment and vehicle type. Additionally, some lenders offer promotional rates or cash-back incentives that hinder an apples-to-apples comparison across offers. Also, add-on products like extended warranties and GAP insurance can further affect loan pricing, making it challenging for consumers to evaluate products. The CFPB study concludes that “price complexity is detrimental to consumers,” and that, “on average, additional complexity (as measured by the maximum possible amount or by the realized amount) led sellers to set higher prices, increased the likelihood that consumers made mistakes and increased transaction prices." The greater the number of individual components that comprise the price for a single item, the greater the likelihood that consumers will be confused and make mistakes and that sellers will profit from the transactions. Truth-in-Lending Act Yet, regulators have long mandated that auto financiers spell out each item in their financing agreements. The federal Truth-in-Lending Act (TILA), enforced by the CFPB, requires lenders and dealers to provide consumers with disclosures that explain auto loan costs and terms. The list of TILA requirements could certainly surpass the 16 sub-prices analyzed in the CFPB’s experiments. For instance, TILA obligates lenders and dealers to disclose a loan’s APR, finance charge, amount financed, monthly payment, number of payments, late fees and prepayment penalties, as well as add-on products — including physical features like alarm systems, window tinting, and tire or wheel protection, plus extended warranties, GAP insurance, service contracts and debt-cancellation products — and even document fees, origination fees, delivery charges and market adjustments that increase the price over MSRP. Why are these pricing elements too confusing for junk fees but mandatory disclosures for TILA? Pricing, not demographics Interestingly, while consumer demographics have long been scrutinized in the financial services sector as the source for various fair-lending violations, the CFPB revealed that, in its pricing experiments, “participants’ demographics did not play a substantial role in their likelihood of making a mistake” when choosing products. “Mistake likelihood was not statistically significantly related to participants’ age, gender, subjective numeracy, objective numeracy or whether English was their first language,” according to the report. Mistakes were more often influenced by the proximity of sellers’ total asking prices. The closer sellers’ prices were to each other, the greater the chance that buyers would make mistakes, the CFPB noted. Put another way, consumers were equally confused by complex pricing structures no matter their background, math literacy or native language. It remains to be seen how the CFPB will implement the takeaways from this new pricing report in relation to lessons learned from previous research efforts.

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