Behaviour around credit card debt

May 12, 2015

YahooI Finance

HOW CREDIT CARD HOLDERS BEHAVE WHEN PAYING OFF DEBTS

THE ULTIMATE GOAL

Being debt free

THE ILLUSION OF DEBT PROGRESS

People are focusing on smaller debts they can pay off substantially or entirely, rather than looking at the big picture and first paying off the credit card with the highest interest rate.

They feel a stronger sense of progress, giving them the motivation to continue towards their main goal.

In fact, by paying off smaller but less expensive debts first they can move that goal further away.

USING EFFORTLESS MONEY

The behaviour is exacerbated when “effortless money” such as a reward or gift is used to pay off a debt.

It is an easy first step towards the ultimate goal.

THE NATURE OF THE DEBT

The illusion of goal progress is enhanced when the debt is used for a hedonic purpose, such as new clothes or a holiday, versus a utilitarian purpose such as health insurance.

People are more likely to pay off hedonic purchases sooner because the associated benefits depreciate faster than those for utilitarian purchases.

“Consumers may feel guilty and don’t want to deal with the hassle of repayments for something with no remaining benefits, so they pay it off sooner,” UTS Business School marketing researcher Francois Carrillat says.

WHAT IS A MORE RATIONAL STRATEGY?

Pay off the debts with the highest interest rates first.

Consolidate credit card debts into one account.

Source: Study of US data from UTS Business School, University of Denver’s Daniels College of Business and Seton Hall University’s Stillman School of Business; Associate Professor Carrillat says findings apply to Australian consumers.