Based on Research By Jefferson Duarte

In Peer-to-Peer Lending, Appearances Can Tell The Truth

  • Trustworthiness is a huge factor in financial transactions.
  • The appearance of trustworthiness influences lenders’ behavior: Lenders are more likely to fully fund loans and give better interest rates to borrowers they perceive as trustworthy.
  • Appearance-based judgments of trustworthiness are usually accurate. Borrowers who look more trustworthy really are more likely to repay loans.

Don’t judge a book by its cover, goes the saying. After all, beauty is only skin deep. And appearances can be deceiving. But according to research led by business school professor Jefferson Duarte and coauthors Stephan Siegel and Lance Young, in some financial transactions, where there’s smoke there’s actually fire. In peer-to-peer lending, the researchers found, borrowers who look more trustworthy to lenders—based on photos alone—have better loan success. Not only that: They have higher credit scores and lower default rates.

Psychologists have understood for some time that people form impressions based on appearance, and that for better or worse those impressions affect social outcomes. Taller men are often perceived to be more adept leaders, for example. Conversely, recent Rice research shows that overweight men are treated less well in retail environments than men who weigh less. Economics and finance researchers, meanwhile, have focused on how perceived attractiveness relates to both pay and assumptions of competence.

Duarte’s research is unique, however, because it focuses on how appearance-based judgments affect perceptions of trustworthiness—and whether those perceptions in turn shape lending decisions.

The research team was interested in appearance-based judgments of trustworthiness because trust is so pivotal in financial transactions. To find out how appearance guided financial decisions, they decided to analyze data from a peer-to-peer lending site. On the site, a potential borrower posts a request for a three-year unsecured fixed rate loan. Her request, called a listing, includes the amount she wants to borrow and the top interest rate she is willing to pay. The site then conducts online auctions in which individual lenders bid on the potential borrower’s request. If enough lenders submit bids, the listing becomes a funded loan.

Because borrowers could upload photographs with their applications, Duarte and his team were able to analyze the role of appearance in this process. Their sample consisted of 5,950 loans, including 3,291 with photographs. First, the team asked 25 people to rate potential borrowers based on photographs alone. To determine the appearance of trust, they asked the raters to rank the trustworthiness of the person in the foreground of each photo on a scale of 1 to 5.

Interestingly, there was no consistency in the images that the potential borrowers posted of themselves. The photos include pictures of the borrowers in uniform, posing with their pets and drinking beer with friends.

Next, the researchers asked raters, “Assuming they have the money to pay you back, what are the chances that they would, in fact, pay you back?” For each question and photograph the team averaged the responses to get a consensus of a borrower’s perceived trustworthiness and perceived willingness to pay.

Perhaps unsurprisingly, a “trustworthy” appearance clearly swayed lenders’ decisions. Candidates with an aura of trustworthiness were more successful at getting a fully funded loan and better interest rates. In fact, borrowers in the top fifth quintile of perceived trustworthiness were offered interest rates 50 basis points lower than borrowers who appeared less trustworthy.

Far more surprising: borrowers who looked trustworthy also turned out to have better credit grades and a lower probability of loan default. Appearance of trustworthiness, in short, accurately matched the borrowers’ character.

The team theorized several explanations for these findings. Though appearance is often a misleading predictor of actual personality traits, it can accurately predict certain behaviors, such as risk taking and aggression.

Perhaps a person’s appearance, some subtle mix of grooming, facial expression and musculature, eventually comes to reflect his or her reputation. Perhaps a trustworthy appearance and trustworthiness itself both have a common biological origin.

The implications are profound for lenders, aspiring borrowers—and future researchers, including ethicists. Is it possible, for example, to identify the specific components that make someone look “trustworthy”?  Which of these is voluntary, such as color of clothing, natural versus synthetic fibers, orthodontia and authentic-looking smiles? And which are the result of life experience, nutrition, even genetics, such as smoker’s teeth, a wide-open smile or elusive gaze? What precisely is the interaction between appearance, treatment by others and behavior?

In short, when it comes to lending, you really can judge a book by its cover. But volumes remain unknown about how and why.

Jefferson Duarte is an associate professor of finance at Jones Graduate School of Business at Rice University.

To learn more, please see: Duarte, J., Siegel, S., & Young, L. (2012). Trust and credit: The role of appearance in peer-to-peer lending. Review of Financial Studies, 25, 2455-2484.