To Reduce Debt, Focus on High Interest Loans First

But consumers take a slightly different approach, according to a consumer behavior expert at Olin Business School, Washington University in St. Louis.

“Our research finds that people really like closing accounts,” says Cynthia Cryder, PhD, assistant professor of marketing. “They will close a small debt account with a low interest rate at the expense of paying down a larger loan with a higher interest rate.”

Cryder, along with co-authors Shahar Ayal, Moty Amar and Dan Ariely of Duke University and Scott Rick of the University of Michigan, designed several studies to examine how consumers manage debt portfolios.

The article describing this research, titled “Winning the Battle But Losing the War: The Psychology of Debt Management” is forthcoming in the Journal of Marketing Research.

Drawing on prior work about the psychology of decisions and goal pursuit, the researchers hypothesized that consumers saddled with multiple debts will primarily be motivated to reduce their total number of outstanding loans, rather than to reduce their total debt across loans, a phenomenon they refer to as debt account aversion.

Throughout a series of debt-management experiments, the researchers found that participants consistently paid off small debts first, even though the larger debts in the study had higher interest rates. In fact, no participant in their sample consistently used their cash to pay off the loan with the highest interest rate.

Because small losses impose a disproportionately heavy psychological burden, the authors argue, eliminating a small debt may offer greater relief than making an equivalent reduction to a larger debt.

Still, “while it is attractive to close an account, that’s not necessarily the best approach to minimizing your debt burden,” Cryder says.

The researchers found a few strategies that help encourage optimal debt management decisions. Debt consolidation schemes that combine several small debt pools into fewer larger ones eliminate tempting small accounts and encourage people to focus on interest rates.

Also, explicitly focusing people’s attention on the actual dollars spent on interest payments encouraged people to prioritize interest rates, and helped them reduce overall debt more quickly.

To optimally reduce overall debt, Cryder says, always put extra money toward loans with high interest rates. When behavior is debt account-averse, consumers are winning the battle, but ultimately losing the war against debt repayment.

Cynthia Cryder
cryder@wustl.edu
(314) 935-8114

Media Contact

Cynthia Cryder Newswise Science News

More Information:

http://www.wustl.edu

All latest news from the category: Business and Finance

This area provides up-to-date and interesting developments from the world of business, economics and finance.

A wealth of information is available on topics ranging from stock markets, consumer climate, labor market policies, bond markets, foreign trade and interest rate trends to stock exchange news and economic forecasts.

Back to home

Comments (0)

Write a comment

Newest articles

Lighting up the future

New multidisciplinary research from the University of St Andrews could lead to more efficient televisions, computer screens and lighting. Researchers at the Organic Semiconductor Centre in the School of Physics and…

Researchers crack sugarcane’s complex genetic code

Sweet success: Scientists created a highly accurate reference genome for one of the most important modern crops and found a rare example of how genes confer disease resistance in plants….

Evolution of the most powerful ocean current on Earth

The Antarctic Circumpolar Current plays an important part in global overturning circulation, the exchange of heat and CO2 between the ocean and atmosphere, and the stability of Antarctica’s ice sheets….

Partners & Sponsors