Borrowing High vs. Borrowing Higher: Sources and Consequences of Dispersion in Individual Borrowing Costs

For many households, paying lower borrowing costs is the surest, fastest way to increase net worth. Using administrative, credit bureau and survey data on U.S. credit cards, we find pervasive and systematic cross-individual variation in borrowing costs. Credit risk and product differentiation explain about one-third of that variation. The remaining riskadjusted dispersion can materially affect wealth accumulation: moving heavy borrowers from the 75 to the 25 percentile of risk-adjusted borrowing costs increases their savings rates by more than a percentage point. Debt (mis)-allocation conditional on cards held could matter in principle, but appears to matter very little in practice, because most people allocate debt to their lowest-rate cards. Rather, similarly risky borrowers often hold cards with very different contract APRs. Heterogeneity in consumer search behavior appears to be an important factor in explaining that contract APR variation – a factor nearly as important as credit risk in explaining the cross section of borrowing costs.