How consumer biases can adversely affect debt management
Consumers need a sound strategy to tackle and prioritise multiple debts and interest rates. To examine the success and failure of debt management, the EU-funded NAIVE DEBT MANAGEMENT (Heuristics and biases in debt management) project identified problem solving approaches that consumers use and biases that influence them when managing debt. It also explored the consequences of such actions on institutions such as banks and credit companies. Project partners developed an interactive debt management game to study debt behaviour, identify sources of poor debt decision-making and gain insight into methods that trigger debt management choices. Players were required to minimise their amount of total debt by the end of the game. Results show evidence of debt account aversion (DAA). Players with and without savings consistently paid off small debts first to reduce the number of debts, even though the larger debts had higher interest rates. Participants made poor financial decisions because of biases such as DAA, interest rate neglect and irrational cash savings. The NAIVE DEBT MANAGEMENT team employed modifications of the game and various experimental methods to better identify sources of inadequate financial behaviour, understand individual differences and practices behind such biases, and study methods to guide consumers towards more ideal and ethical decisions. A series of studies show that individual differences in information processing style are flexible and can be modified by situational factors. Factors that generated analytical thought improved the quality of financial decisions. Biases prevailed among consumers with limited benefits and time for processing and understanding information. Researchers also tested different ways to reduce irrational decisions in experiments, specifically DAA. One notable finding was that eliminating participants' ability to fully repay small debts improved their overall financial situation. NAIVE DEBT MANAGEMENT shed light into how people perceive and cope with multiple financial accounts that may lead to sound financial management. This will also help financial institutions and policymakers to develop tools and techniques that benefit consumers.
Keywords
Biases, debt management, NAIVE DEBT MANAGEMENT, debt account aversion
