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Why Don't People Manage Debt Better?

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Re: Why Don't People Manage Debt Better?

#91

Post by dragontamer »

bradleyjg wrote: post #58
imgabe wrote: post #17

Anyone at a point where they are making monthly payments on multiple credit cards has already lost the debt game. People don't manage debt better because they have been marketed to and taught to use debt completely inappropriately. Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is how businesses use debt and t…

I don't think such an absolute position is warranted. It's true that saving up for a big purchase will end up costing you less money than borrowing to pay for it and paying it back. But you will have the item purchased for less time. Suppose you have enough disposable income to pay for a new $1200 TV over the course of 12 months. In scenario 1, you save $100 each month. The bank pays you 0.5% interest. As of January…

Now suppose you lose your job in Month 10. The TV-less person will continue not having a TV, and use those funds for emergency day-to-day living expenses as he (or she) gets his life back in order. You can even dip into your credit card credit line for an emergency.

But the person who bought the TV on interest is in debt, has less credit to live off of, and only a TV to show for it.

-----------

In either case, saving up a pile of 6-months of expenses cash-on-hand is a good strategy. If you have 6-months of expenses saved up, you simply buy the TV with that money, and then in a year you put money back into your cash account.

Look, now you have the benefits of all strategies! Saving up money for emergencies, or even large expenses (LONG before you even think about those expenses) is the way to go.

Re: Why Don't People Manage Debt Better?

#92

Post by zrail »

crystalmeph wrote: post #68
zrail wrote: post #19

Earlier quoted context omitted.

> Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. In 2014 only 34% of households carried credit card debt month to month[1]. The majority of households pay it off every month, simply using it to smooth out irregular cash flow while potentially racking up rewards. They're not purchasing an asset, per se, unless you c…

I'm not well versed in the history of consumer debt, but 34% carrying month-to-month debt seems historically high, since consumer credit cards were only widely introduced in the mid-20th century[1], and took a few decades to reach mass penetration. The page you linked to shows that even the events of 2008-2009 didn't set people back from expanding their personal debt, which is surprising to me. Given our fairly short…

> The page you linked to shows that even the events of 2008-2009 didn't set people back from expanding their personal debt, which is surprising to me.

The page I linked, under the heading "Transactors versus revolvers," presents a chart that shows the percentage of households with revolving debt declining from 44% in 2009 to 34% in 2014. A 22% decrease over five years is rather significant, no?

Re: Why Don't People Manage Debt Better?

#93

Post by _yosefk »

yummyfajitas wrote: post #27
imgabe wrote: post #17

Anyone at a point where they are making monthly payments on multiple credit cards has already lost the debt game. People don't manage debt better because they have been marketed to and taught to use debt completely inappropriately. Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is how businesses use debt and t…

Consumption smoothing is a perfectly valid use of debt. Suppose I have utility = log(consumption), but my income is volatile. If I have 1 income in year 1 but 10 income in year 2, and use no credit, my utility is log(1)+log(10) = 2.3. If I use credit, I can have utility log(5.5 / (1+r)), with r the interest rate. At 10% interest, that's 3.2. At 20% interest that's 3.0. At 50% interest that's 2.6. So even at 50% inter…

I suspect that the average person - actually, make it 99.5% of the people - is better off with advice along the lines of "if you can possibly help it, don't get into debt to buy anything that can't be used to make enough money to offset the interest, and be very careful even " then "get into debt as long as the utility offsets the interest."

I think so because I doubt that most people (regardless of how good they are at math) can trust their current selves to compare utility from consumption to disutility from having to pay back (meaning that their future self will often disagree strongly with their current self.) This is not to say that someone else should be trusted with decisions about savings and loans other than the saver/borrower (forcing someone to put money into a pension fund on the grounds that they're irrational and then not really paying the pension back is a bit too common for my taste), just that "by default, don't get into debt" is good advice.

More generally, IMO quite often clever utilitarian maximization works worse than simple rules designed to keep you out of trouble first, and seek "utility" later. (I guess I don't quite believe in people being utility-seeking machines, not to mention ones having stable preferences, nor do I believe that a person is truly better off having achieved more utility per unit of time.)

I realize it's not a satisfactory argument, of course, if one does believe in utility maximization as a good way to think about these things, and I really wish I could back this up so it's more than a hunch...

Re: Why Don't People Manage Debt Better?

#94

Post by taneq »

imgabe wrote: post #17

Anyone at a point where they are making monthly payments on multiple credit cards has already lost the debt game. People don't manage debt better because they have been marketed to and taught to use debt completely inappropriately. Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is how businesses use debt and t…

> Carrying a balance on a credit card is almost never an appropriate use of debt.

One exception: Credit cards with those introductory "6 months interest free" clauses. Sign up for as many as you can get, with as large a limit as you can get. Max them all out on payments into a mortgage offset account. Just before the end of the interest free period, pay them all off again. (I've heard of this being done but I'd bet it's a lot harder to pull off these days.)

Re: Why Don't People Manage Debt Better?

#95

Post by ac29 »

bradleyjg wrote: post #58
imgabe wrote: post #17

Anyone at a point where they are making monthly payments on multiple credit cards has already lost the debt game. People don't manage debt better because they have been marketed to and taught to use debt completely inappropriately. Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is how businesses use debt and t…

I don't think such an absolute position is warranted. It's true that saving up for a big purchase will end up costing you less money than borrowing to pay for it and paying it back. But you will have the item purchased for less time. Suppose you have enough disposable income to pay for a new $1200 TV over the course of 12 months. In scenario 1, you save $100 each month. The bank pays you 0.5% interest. As of January…

> Suppose you have enough disposable income to pay for a new $1200 TV over the course of 12 months. In scenario 1, you save $100 each month. The bank pays you 0.5% interest. As of January 1st next year you'll have a new TV and $2.75. In scenario 2, you put $1200 on a credit card with a 10% APR. You pay $100 each month towards the credit card bill. As of January 1st next year you have a TV you've been watching for a year already and owe $69. You've essentially paid $72 for the privilege of getting the TV you wanted a year earlier.

I think this is a good point, but the sort of people who would need a year to save $1200 do not have the sort of credit to get a 10% APR credit card, APR's closer to 20% or higher are more likely. Run the math again at 18% APR ($133 in interest over the 14-month payoff period) or even 24% ($185 in interest over the 14-month payoff period), and you quickly see just how much premium it costs to get that TV a year earlier.

I'm ignoring the negligible savings rate interest in your example and, probably foolishly, assuming this hypothetical person only has this single CC debt.

Re: Why Don't People Manage Debt Better?

#96

Post by njharman »

kdamken wrote: post #42

Better question: why do people buy things they can't afford and most often don't need, putting themselves in this position? So many of my peers don't make a lot of money, but then still go out and buy a new or newish/used car and put themselves on a multiyear payment plan. "Oh but it's only 200 a month, I can swing that". Repeat for like 3-4 other things and suddenly they're always complaining they have no money and…

> why do people buy things they can't afford and most often don't need

Advertising.

Most people are afraid?/too proud? to admit or even consider they may not be 100% rational or 100% in control of the own actions despite numerous studies showing you are not

Advertising, very obviously, manipulates people into making choices. Most of which are not in their interest. The original article even has an example; in the three kinds of ads for loan. One ad was twice as effective. In advertising, "effective", "conversion rate", etc all mean better at manipulating people into making the choice the advertiser wanted.

Some documentaries https://www.quora.com/What-are-some-great-documentary-films-... you can google for papers/studies. Or, just bury your head in the sand.

Re: Why Don't People Manage Debt Better?

#97

Post by infinite8s »

yummyfajitas wrote: post #87
infinite8s wrote: post #76

Earlier quoted context omitted.

Why is utility modeled concavely?

My utility from eating (in one time period) $800 worth of food is less than 2 x utility of eating $400 worth of food. Doubling my consumption doesn't double my happiness. Concavity is a way of formalizing this intuition; it means, roughly speaking, that f(2x) Econ uses log(x) as a simple model, but the same idea would apply to any convex function albeit with different arithmetic.

Thanks, that makes sense. I guess that's why flat income tax rates are considered "unfair" since they are modeled on a linear expectation of utility.

Re: Why Don't People Manage Debt Better?

#98

Post by infinite8s »

maxsilver wrote: post #86
zrail wrote: post #48

Earlier quoted context omitted.

Interesting. What card is this?

American Express has a card "Blue Cash Preferred". You get 6% back on Groceries (up to $6k/yr), 3% back on gas, and the card has a $75 annual fee. If you only use the card to spend $100/week on Groceries, you get $312 in cashback rewards. Subtract the $75/yr fee, and Amex paid you $237 to use their card that year. (Amex isn't the only card like this -- there's lots from MasterCard and Visa as well. This card in parti…

I don't understand these reward schemes. Surely they are being funded by higher merchant fees, which means merchants charge more, which just means that the rewards are a transfer scheme between people who pay by cash/unrewarded cards and those with rewards cards.

Re: Why Don't People Manage Debt Better?

#99

Post by dazc »

bradleyjg wrote: post #58
imgabe wrote: post #17

Anyone at a point where they are making monthly payments on multiple credit cards has already lost the debt game. People don't manage debt better because they have been marketed to and taught to use debt completely inappropriately. Debt should be used to purchase an asset that will appreciate or otherwise provide an income in excess of the interest payment on the debt. Full stop. That is how businesses use debt and t…

I don't think such an absolute position is warranted. It's true that saving up for a big purchase will end up costing you less money than borrowing to pay for it and paying it back. But you will have the item purchased for less time. Suppose you have enough disposable income to pay for a new $1200 TV over the course of 12 months. In scenario 1, you save $100 each month. The bank pays you 0.5% interest. As of January…

> Suppose you have enough disposable income to pay for a new $1200 TV over the course of 12 months.

If you don't have $1200 for a TV you shouldn't be buying it. It's not as if you can't buy a perfectly reasonable TV for much less is it?

Re: Why Don't People Manage Debt Better?

#100

Post by njharman »

pilom wrote: post #8

This 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…

If you can't handle LoC/CC (and you obviously can't if you've collected so many debts that you struggle to manage them), it makes sense to pay off and close small ones. Because the risk you will run up those lines is worse than the sub-optimally paying off total debt.

I.e. For many, five loans with $1000 avail credit will become $5000 more debt. Better to make that four (or three, or one) loan, even if remaining loans have higher interest rate.

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