A Behavioral Approach to Reduce Your Debt

“The key to happiness is low overhead and no debt.” – Lynda Barry

Since average credit card rates are much higher than average financial market returns, taking on more debt is an easy route to creating a negative net worth.

There are many strategies focused on saving more but not a whole lot gets written about debt repayment strategies, other than the usual “live below your means” and “pay yourself first” advice.

These are great pieces of advice, but don’t do much good for those who are already swimming in debt and need to pay it off.

I recently read a study called Borrow Less Tomorrow: Behavioral Approaches to Debt Reduction that offers some interesting solutions.

The study looked at consumers with credit card balances and used the following strategies to help them pay off their debt:

1. Those in debt would meet with the staff to come up with different repayment strategies. They looked at simple spreadsheets to show the impact of various monthly payments and the effect they would have on payoff time and interest paid. This included accelerated plans that would increase the amount paid back each month by a small amount.

2. They would get friendly reminders via text or email each month to remind them of their debt repayment goals.

3. They would tell at least one friend (or more) about their goals and the plan so they could also remind them if they got off track.

The results of the study showed that after 12 months, 51% of those surveyed were on track with their debt repayment plan and 41% used the plan to accelerate debt payments to pay them down faster.

Much as fear and greed can dictate out investment decisions, behavioral biases can affect our debt loads as well. From the study:

“Mounting evidence suggests that behavioral biases and cognitive limitations (which we refer to loosely as “behavioral factors”) depress wealth accumulation.”

So, the same biases that lead us to save too little also lead us to borrow too much. As this study shows, coming up with a system or process to pay off debt can help get rid of the wealth destruction that is credit card debt.

Lessons:

• Create a long-term system and use different scenarios to understand all the costs involved with debt.
• If you are having trouble paying off debt, utilize automated reminders (texts, daily smartphone alerts, emails, etc.) to stay on track.
• No one likes to discuss their finances with others, but it can be effective. Tell one of your friends or family members about your goal to reduce debt and make sure they check up on you periodically to keep you focused.

Source:
Borrow Less Tomorrow

Further Reading:
Save More Tomorrow