(October 3, 2020) SBFA contracted with Kingsley-Kleimann Group to test 24 small business owners/executives in California and New York, examining how they understand commercial loan disclosures and use them make short-term financing decisions. In Round 1, Kingsley-Kleimann tested the Capital Comparison Chart Disclosure and three SBFA-developed Disclosures. In Round 2, Kingsley-Kleimann again tested the Capital Comparison Chart Disclosure and two SBFA-developed Disclosures. The key findings are as follows.
(1) More information was not – necessarily – better for individuals. Additional information often gives individuals a sense of security. Armed with more details comes a sense that that a person has “all they need” to make a decision. However, in this case, more information in the form of the detail-heavy Capital Comparison Chart Disclosure did not aid individuals. In fact, they performed more poorly using this disclosure in cognitive questioning. They were less able to identify the payment frequency, the payment amount, or how APR is used. They also perceived other disclosure options as easier to understand.
(2) APR is a complicated measure that does not always aid individuals as intended. The impetus in using APR is to provide a cross-product measure presenting the actual yearly cost of funds over the term of a loan. However, APR – in this context of short-term loan disclosures – had several issues.
- Individuals conflated APR with interest rate and become confused. Individuals mistakenly believed that the rate they saw on the disclosure is the interest rate. In fact, this is a strong cognitive map for most individuals; they fundamentally believe APR and interest rate are the same thing. Often, individuals tried to “do the math” by assessing the cost of the financing in relation to the overall amount of the loan. The math, of course, doesn’t add up to the APR – which created confusion. As a result, individuals did not fully understand what APR is or how it relates to their loan offer.
- Because individuals don’t understand APR, they question it. When individuals hit something they fundamentally don’t understand, it stops their cognitive process. Individuals were not fully able to use the disclosure because key metrics did not match their long-held cognitive maps.
- Individuals found other metrics as more helpful than APR. In light of the misunderstanding of APR, individuals articulated that the cost of financing was more helpful than the APR in determining the best loan option.
Comprehension of APR in relation to commercial loans is a problem. Some commercial loans are not annual in nature and are repaid on a daily basis, which can cause a much higher APR than on other loans. APR is often touted as being an “apples to apples” comparison, but in some cases, comparing a short-term finance loan to an annual loan is like “apples to avocados.” They are very different fruits – though both are sometimes green. Consumers, however, believe they are comparing an apple to an apple, and this is a concern. Comprehension is undercut when consumers don’t have the cognitive framework to understand a complex construct. It is undercut further when they are asked to use a flawed understanding to make comparisons.