When It Comes To Repaying Debt, Consumers Erroneously Prefer Molehills Over Mountains

Nov 09, 2011, 10:07 ET from American Marketing Association

CHICAGO, Nov. 9, 2011 /PRNewswire-USNewswire/ -- New research published in the Journal of Marketing Research shows consumers consistently tackle small debts first, even though they'd save more money in the long term if they paid off larger, higher-interest debts first.

A big pile of bills to pay is enough to frighten most consumers, and consumers are facing some big piles during this recession. But new research published in the American Marketing Association's Journal of Marketing Research shows consumers put forth a disproportionate amount of effort to pay off their smallest debts first rather than put that extra effort toward paying down bigger debts with higher interest rates that cost them more.

The authors of "Winning the Battle but Losing the War: The Psychology of Debt Management," Moty Amar, Dan Ariely, Shahar Ayal, Cynthia E. Cryder and Scott I. Rick, asked study participants to play a series of debt-management games to understand how consumers approach debt payments. They found that consumers often work to reduce the overall number of loans they have, which means they aggressively work to pay off their smallest debts first, rather than focus on paying off their bigger, and ultimately more costly debt. The authors say consumers are debt-account averse and smaller debts feel more manageable than larger ones. Discharging easy debts makes them feel like they are making progress on their debts when, in reality, doing so may be costing them more in the long run.

The lab experiment also included scenarios that forced participants to pay more attention to their larger, costlier debts. "Restricting participants' ability to completely pay off small debts actually helped them to reduce overall debt more quickly," the authors say.

The authors say understanding how consumers manage debt can help lenders develop tools that can help consumers get out of debt more quickly. For example, a credit card company, if so inclined, could draw attention to interest rates by highlighting the total dollar amount of interest that has accrued on the debt, rather than printing in small type the amount of interest accrued since the previous billing cycle, as is the typical practice.

At the same time, the credit card company could also show a card holder how much less he'd pay and how many fewer payment he'd have to make if he doubled his minimum payment each month.

The research will appear in the November, 2011 issue of the American Marketing Association's Journal of Marketing Research.

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Contact: Christopher Bartone – 312.542.9029 – cbartone@ama.org

SOURCE American Marketing Association