Mortgage borrowers frequently make bad decisions, in part reflecting the complexities of mortgages and the mortgage process. But a major part of the problem is that the decision process used by many (if not most) borrowers is deficient, and the marketing approaches used by loan originators reinforce the deficiency.

In his insightful new book, "Thinking Fast and Slow," psychologist Daniel Kahneman posits that people behave as if they have two decision systems: A system 1 "operates automatically and quickly, with little or no effort," while a system 2 "allocates attention to the effortful mental activities that demand it, including complex computations."

System 1 is quick and effortless but often wrong, whereas system 2 requires effort but is wrong less often.

Politicians selling themselves usually appeal to the system 1 of voters, which is a weakness of democracy. Advertisers selling products or services usually appeal to the system 1 of consumers, which is a weakness of capitalism.

The immediate consequences of a course of action are usually accessible to system 1, while appreciation of long-run consequences is more likely to require the engagement of system 2. Because involvement of system 2 is work and is resisted, long-run consequences are often given insufficient weight in the decision process.

Home mortgages are a great example. The system 1 focus is the cash required to close the transaction and the initial monthly payment. Assessing the impact of a transaction on the borrower’s wealth and payments in future years is complicated and requires the engagement of the borrower’s system 2, which is resisted.

Borrowers who participate in the mortgage decision process solely through their system 1 are very likely to make bad decisions. In the past, I have written about borrowers who did really dumb things because they were "cash-dazzled" or "payment-myopic." These are system 1 pathologies.

Customary methods of marketing mortgages reinforce the tendency of borrowers to rely on their system 1. The key words used by loan originators, such as "savings," "lowest rate," "quick," "no-cost" and "guaranteed," appeal to system 1.

From the standpoint of loan originators, engaging the system 2 of borrowers to consider long-run consequences is risky because it may make the borrower uncertain, which can delay and possibly derail the deal.

After reading Kahneman’s book, I realized that the articles, calculators and spreadsheets on my website are all designed to engage the system 2 of mortgage borrowers.

In recent years, I have also begun to realize that the impact of such aids was limited because they were not part of the loan process and therefore not immediately available to borrowers when they were making decisions.

For example, a major decision a borrower has to make is the type of mortgage: whether fixed-rate or adjustable; if fixed-rate, the term; and if adjustable, the initial rate period.

There are mortgage calculators that show the long-run as well as the short-run consequences of different choices, but the borrower has to enter the mortgage prices, which are critical to the decision. Borrowers in shopping mode must take time out to deploy a calculator, enter their best guess as to prices, and then return to their shopping; however, this is clumsy.

What was needed, I realized, was a way to integrate the calculator into the loan process so that it emerged at the exact point where the borrower had to make a decision, with the correct prices already entered. The long-run consequences of alternative decisions, using live prices, would then become immediately apparent, forcing the borrower’s system 2 to respond.

Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at He has worked to create a loan network, launched in January, to help address some of the issues mentioned in this column.

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