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This article was published 1/4/2017 (1535 days ago), so information in it may no longer be current.
If you’re waging a battle with debt and you feel like you’re losing, you may want to pay attention to new research that could give you an upper hand in this financial fight.
A recent study by a University of Manitoba professor, along with other academics from Georgetown University, the University of Alberta and Boston University, found that many people may be taking the wrong approach to paying down debt.
Moreover, the study points to strategies that may be more effective that run counter to a lot of the predominant thinking regarding debt repayment.
"What our study looked at is what motivates consumers to repay their debt," says Keri Kettle, an assistant profession of marketing at the Asper School of Business at the University of Manitoba.
The main focus of the research was individuals who have multiple credit card balances, adds Kettle, who specializes in consumer psychology.
But it’s applicable to anyone who is struggling to pay off debt.
Canadians could use some help. According to economic data from TD, Canadian households owed more than $2 trillion at the end of 2016 — up by about $30 billion from the year before.
And consumer debt — credit cards, for example — accounts for almost $600 billion of that sum.
With respect to the study, researchers examined anonymous U.S. consumer data provided by HelloWallet, a sponsor of the research, which provides app-based financial management tools for employees of U.S. companies.
But Kettle says the findings will resonate here in Canada too because Canadian and U.S. consumers share a lot of similarity in their behaviour when it comes to credit cards.
"Those who have balances across multiple credit cards are the people going to be faced with the same challenges whether they’re in Canada or the United States."
Moreover, he adds, the study involved social experiments to follow up on the findings from the raw consumer data, which were carried out at the University of Alberta involving Canadian subjects.
Perhaps the most stunning result of the research is that consolidating multiple credit card accounts into one big account at a lower interest rate is not as beneficial as people assume, says Simon Blanchard, an assistant professor of marketing with McDonough School of Business at Georgetown University in Washington, D.C.
"When you put all your debt in one account, typically the benefit is that it does come with a reduced interest rate, and that’s a good thing," he says.
"But the downside with (it) is when people are applying their payments, they feel like there’s very little progress because it’s just one big debt."
This can be incredibly de-motivating.
"The idea is it’s difficult to stay motivated if you’re paying a couple of hundred bucks a month, for example, against $30,000," Blanchard says.
"You feel like you’re not making progress."
This insight is useful, even for those of us who don’t carry credit card balances but instead may have debt on lines of credit that permit interest-only payments.
"I think our research can speak to that," says Kettle, who also worked on the study with Remi Trudel at Boston University and Gerald Haubl at the University of Alberta.
Although their work did not examine lines of credit, the findings seem to suggest moving your credit card debt to a low-interest line of credit does not lead to faster repayment.
"It’s tough to argue that someone shouldn’t take money off a 20 per cent interest credit card and put it on a five per cent line of credit," he adds.
"Rationally, that’s the right thing to do because you’re saving 15 per cent interest, but the flipside is, as our data points to, this strategy will decrease the amount that they pay by about 15 per cent."
In other words, it’s likely to be a wash.
But their research provided other insights, too.
For one, the consumer data revealed people tend to choose one of two strategies when paying down multiple credit card debts.
They either spread payments to all accounts evenly, or they make the minimums on all and then allocate the remaining cash to one debt.
"What we found when a person makes a concentrated payment, the next month they’re likely to pay more money down on the debt," Blanchard says.
Again this speaks to motivation. People are more motivated when they’re seeing progress.
But perception is more important than actual arithmetic.
For example, if you owe $5,000 and make a $100 payment, it will feel more satisfying if you have the debt broken down into five separate accounts of $1,000 than if you made the same payment against the entire debt in one account.
"In psychology, we call this a ‘sub-goals’ strategy," Kettle says, adding people use this kind of mental math all the time.
For example, we will often break down a long road trip into pieces so it will not seem as tedious.
"What’s different about credit cards" is unlike a road trip, there is no set order to follow, he says. You’re not going from point A to B and then to C.
"When you’re paying off credit cards, you can choose any way you want," and about 50 per cent of the people in the study tend to make the wrong choice: They make equal payments against all debts.
The better strategy is making minimum payments on all cards, and then focusing on paying the smallest debt first because you feel like you’re making the most progress.
And when you feel like you’re gaining ground, you are more motivated to pay off the debt.
Blanchard adds this finding runs somewhat counter to previous research.
"People have been arguing for some time that what’s motivating is how close you are to the finish line of closing an account," he says.
"But we’re saying that it’s really about how much of a dent you’re making that will have the most impact."