Consumer behavior and debt is one of marketing professor, Ali Besharat’s research interests. So it’s not surprising that his findings indicate how irrational that behavior can be–and even worse–costly.
He has 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 we are making progress on our debt by eliminating one creditor is more powerful than the money we lose by not slapping that dough down on the high-rate debt. A report called the “Illusion of Goal Progress in Credit Card Repayment” is in the Journal of Public Policy & Marketing.
We asked Besharat for his advice for consumers dreading that post-eggnog debt hangovers.
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 loan debt. They’re a very, very expensive type of borrowing.
The July 2014 report from the Federal Reserve indicates that the size of total U.S. credit card debt is now $882 billion. Divide that by the number of consumers, and it amounts to $5,600 per individual—which is huge. (If you think that’s scary, when Nerdwallet.com counted only indebted households, the average household credit card debt was $15,611.)
Thirty-four percent of consumers live off of credit cards, and at the end of the month, they cannot pay off their debt. Debt grows from month to month which adds to the total cost of borrowing.
Q: Is what you call the “illusion of progress,” the false impression that by reducing the number of creditors you’re actually gaining on, ever a good thing? Doesn’t it tend to keep a consumer motivated to eliminate debt?
A: Unfortunately, no. When people focus on small goals, they tend to be distracted from the main goal. 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 proves that the more uncomfortable we are with what we borrowed money for, the more irrational we become about paying it off.
A: When we spend for more pleasurable expenses, we tend to get rid of that debt faster. If you buy a watch for $1,000 versus a dishwasher for $1,000, you feel guilty about your hedonic purchase. You don’t want that debt to hang around your head.
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, you 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 interest 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.