One of research interests is consumer behavior and debt. So it’s not surprising that he’s studied how that behavior can be irrational — and worse: costly.
In fact, he’s shown that consumers are more likely to first pay off the credit card with the lowest balance — not the highest interest rate. The illusion that they were making progress on their debt by eliminating one creditor was more powerful than the money they lost by not slapping that dough down on the high-rate debt. Or worse: They may not understand how that math actually works.
This fall Besharat published in the Journal of Public Policy & Marketing.
We asked Besharat for his advice for consumers who are dreading their own .
Q: What took you down this path in your research?
A: What inspired it was a personal experience and casual conversation I had over this topic a few years ago. I had a store credit card as well as a bank credit card, and I made a few purchases in 2009. And when it came down to making the payment, I just disregarded the interest rates. The store card was around $400. And after I (paid it off), it occurred to me, why didn’t I look at the interest rate?
So then I asked, is it me or is this something going on with other consumers, who actually try to make some achievement and feel happy about it?
Q: How big a financial hit are we talking about here?
A: First off, credit-card debts are the most expensive types of debt, compared to mortgage debt and even student-load debt. They’re a very, very expensive type of borrowing.
And there are new reports from July 2014 from the Federal Reserve that show the size of total U.S. credit-card debt is now $882 billion. Divide that by the number of individuals and it’s $5,600 per individual — which is huge. (If you think that’s scary, when Nerdwallet.com counted only indebted households, average household credit-card debt was $15,611.)
What’s more fascinating is 34 percent of people live off of credit-card debt. At the end of the month, they cannot pay off their debt. They let their debt grow from month to month, which adds to the total cost of borrowing. One in 3 people do this.
Q: Is what you call the “illusion of progress” — the false impression that by reducing the number of creditors, you’re actually gaining on your debt — ever a good thing? Wouldn’t it tend to keep a person motivated to eliminate debt?
A: Unfortunately, no. When people focus on small goals, they tend to be In psychology, they talk about “soft goals,” and we see this in people on a diet. If the soft goal is to lose 2 pounds a week, as soon as people achieve the subgoal, they tend to lose sight of the big goal. With credit cards, this sometimes actually may put consumers in danger.
Q: Your research also showed that the more uncomfortable we are with what we borrowed money for, the more irrational we become about paying it off.
A: When people spend for more pleasurable expenses, they tend to get rid of that debt faster — if you buy a watch for $1,000, versus a dishwasher for $1,000. People feel guilty about their hedonic purchase. They don’t want that debt to hang around their heads.
If the interest rate on the hedonic purchase is higher, absolutely you have to focus on that one. But when the interest rate on (the watch) is lower, they keep focusing on that one. (Consumers) don’t pay attention to the economic cost of debt. They let emotions make that decision.
Q: So what would you advise consumers to do when they’re looking at their credit-card statements after the holidays?
A: The smart decision is (based on) how much balance you have, and how much the rate is on each piece of that debt. And forget about the source of the money — irrational behavior affects windfall money more than hard-earned money. Don’t let your mind trick you.
Q: What’s your own holiday debt like?
A: Ha! I tend not to revolve debt at all. I don’t think that credit cards are the cheapest way to spend money.
Susan Clotfelter: 303-954-1078, sclotfelter@ denverpost.com or twitter.com/susandigsin
Time and money
How long would it take you to pay off $5,600 in credit-card debt, and what would it cost?
By January 2016, at 15 percent interest: You’d have to pay $469.40 monthly, and the money would have cost you $502.17.
By January 2017, at 15 percent interest: You’d pay $262.21 monthly, and the money would have cost you $955.15.
By January 2016, at 18 percent interest: You’d pay $477.35, and the money would have cost you $605.50
By January 2017, at 18 percent interest: You’d pay $270.28, and the money would have cost you $1,156.88
By making a $100 payment, with an interest rate of 18 percent: It’d take you nine years and 11 months to pay it off, and the money would have cost you $6,206.77 — making your total payout more than twice what you borrowed.
In the really scary department: That household debt of $15,611: At 18 percent interest and paid off at the rate of $250 per month, would cost you more than $30,000 in interest and require more than 15 years to pay off.
— Source: Nerdwallet.com Credit Card Debt Payoff Calculator; Creditkarma.com debt repayment calculator
