Why Don't People Manage Debt Better?
blogs.scientificamerican.com
Why Don't People Manage Debt Better?
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Re: Why Don't People Manage Debt Better?
#2When a late payment is $39.99 and a mark on your credit record, even the smallest, lowest-interest debts become high-risk. Reducing the number of risks (and mental energy managing them) easily outweighs the interest differences.
When you have to spend a 1/2 day to refinance a credit-card to an unsecured personal loan, it's not always a clear win: you might not get the loan, or the loan offered might have significantly higher interest rate than advertised, etc.
Re: Why Don't People Manage Debt Better?
#3I used to think that the medieval western distrust of usury was backwards and foolish.
Then I read about the roman experience with debt, and now I am far less sure of that.
Re: Why Don't People Manage Debt Better?
#4If all things were equal, and your repayment terms were a fixed artifact, the strategy assumed to be optimal in the article would be correct -- it would make more sense to focus on the higher interest rate to avoid accruing interest. But they aren't.
Credit cards in particular are tough -- if you have alot of debt and credit lines and don't make significant impact on principal, they start cutting credit limits, which incurs fees. Interest on fees and fees have payment precedence over regular interest and principal, so it starts a vicious cycle. You end up in a situation where the banks assume you will default, so to compel you to pay more to them, the credit card will drop your limits to trail your balance.
So you really have two priorities: paying down debt and maintaining credit lines to avoid capricious changes in your payment terms.
When you have lots of credit lines, minimum payments start to matter alot, as they sap your re-payment power. If you focus on closing the smaller accounts and walk your payment focus up the stack, you'll be able to make more significant payments and stay afloat. When you make alot of progress, you have a higher likelihood of refinancing the bigger debts, which is ultimately where you save on the high-interest accounts.
Re: Why Don't People Manage Debt Better?
#5Good article and interesting study with multiple psychological inputs. I think debt in general is difficult to process mentally because "negative" money is quite different than "positive" money. Money that you have can be visualized - you can spend it or even pull it all out in cash and see exactly how much it is and how it grows or shrinks. Debt is purely a number on piece of paper or a screen. You can't "run out" of debt or go to the bank and get your debt in negative dollars. So without paying careful attention to financial rules like compound interest, dealing with debt is something that humans just aren't inherently very good at.
Re: Why Don't People Manage Debt Better?
#6Even professional economists struggle to understand the exponential function.
Re: Why Don't People Manage Debt Better?
#7When a late payment is $39.99 and a mark on your credit record, even the smallest, lowest-interest debts become high-risk. Reducing the number of risks (and mental energy managing them) easily outweighs the interest differences. When you have to spend a 1/2 day to refinance a credit-card to an unsecured personal loan, it's not always a clear win: you might not get the loan, or the loan offered might have significantl…
Exactly. Every small balance is a potential disaster in the making, an autopay that inexplicably fails, a teaser interest rate that expires, an unexpected annual fee or recurring charge from a merchant, a supremely annoying hour on the phone, etc. I had the exact same reaction to that part as you did. If you're going to evaluate economic actors for rationality you have to make sure your assumptions of what's rational are well grounded first.
Re: Why Don't People Manage Debt Better?
#8This is showing that the Dave Ramsey "debt snowball" (pay off smallest debts first to get a psychological win and some breathing room by having fewer minimum payments) is a more effective way to get people to pay off many separate debts than paying off "highest interest rate first" even if it is less optimal for a rational actor. Just another case of people aren't 100% rational that many people have known for a while.
Re: Why Don't People Manage Debt Better?
#9When a late payment is $39.99 and a mark on your credit record, even the smallest, lowest-interest debts become high-risk. Reducing the number of risks (and mental energy managing them) easily outweighs the interest differences. When you have to spend a 1/2 day to refinance a credit-card to an unsecured personal loan, it's not always a clear win: you might not get the loan, or the loan offered might have significantl…
Many online companies now let you get a personal loan in far less time, id say in under an hour for most people. There may be a veritification process that adds on time but it's definitely not required for everyone (and usually are for people who are uncomfortable with online verification)
Re: Why Don't People Manage Debt Better?
#10I used to think that the medieval western distrust of usury was backwards and foolish. Then I read about the roman experience with debt, and now I am far less sure of that.
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