High Interest Loans - Motivations of a Customer
Information, process, and cost, the status quo, intertemporal considerations, mental accounting, and a negative perception of the banking industry are five motivating factors driving the high-interest loan customer.
- Debt accumulation is on the rise among consumers in the US. While a lot of research has gone into identifying strategies that consumers can employ to reduce or eliminate their debt balances, it might be unavoidable for some.
- Along with the rise in overall debt among US consumers, many of them hold high-interest debts, which might be unsustainable in the long run. As such, a look into the psychological reasons behind their demand for such debt would provide a background for what motivates them to choose high-interest debts over low-interest debts.
INFORMATION, PROCESS, AND COST
- Research provides that consumers go for high-interest loans for psychological, as well as structural reasons. High-interest loan consumers are usually affected by a lack of knowledge and understanding of some low-interest loans, as well as the upfront costs associated with them.
- Unlike high-interest loans that are commonly associated with credit cards, which are popular and widely advertised, consumers might not know about low-interest loan alternatives. Credit card companies facilitate this trend through their rigorous marketing methods, often extending as far as mailing offers to consumers directly and regularly. For example, credit card companies in the first ten months of 2015, sent out 3.2 million mail pieces to consumers. Some mails sent included pre-approved offers for new credit card products.
- Despite being aware of other alternatives, consumers also avoid more cognitive loan choices that require them to take many terms into account, as well as complicated mental calculations.
- Also, the fear of upfront costs, as well as high switching costs when considering low-interest loans serve to deter consumers.
THE STATUS QUO
- Being that high-interest loans are seemingly widely used and accepted, several psychological factors influence consumers into sticking with the status quo.
- Familiarity with a brand or product usually breeds loyalty, and due to consumers' general acceptance of high-interest loans as the norm, they are usually inclined to rate them as better.
- Such familiarity inclines consumers to see high-interest loans as a better option and might promote positive feelings to continue using them rather than the alternative, which they ignored. Psychological factors also contribute to making perceived costs attached to less utilized loan options seem more costly than they are.
- Consumers also prefer to avoid the stigmatization or negative feeling that comes with actively taking out a loan, and would rather accept a high-interest debt that accumulates passively, for example, from credit cards.
- A lower connection to one's anticipated future self also drives consumers to use high-interest loans, as they do not require them to commit to developing a repayment strategy or plan.
- Credit card and payday loans roll over and do not require consumers to devise a plan to pay back even though they would have to do so eventually. As such, consumers who lack emotional connection or foresight into their future are more inclined to go for such options and are less likely to consider the cheaper low-interest alternatives.
- Research shows that self-control issues and high discounting levels have some bearing on excessive credit card borrowing. Consumers can thus be debt-averse, as time discounting allows them to postpone repayment to a later date.
- High-interest loan consumers have more flexibility regarding how much and when to repay their debts compared to low-interest alternatives.
- Some consumers strongly dislike uncertainty and do not believe they will have a lot of wealth in the future. As such, they view low-interest loans, which are usually inherently rigid, as riskier prospects.
- The mental account of high-interest loans such as credit card loans by consumers as small losses and are easily ignored. However, these loans usually accrue to become a significant debt. Whereas, low-interest loans are usually undertaken to accommodate for a large project or expense. As such, the losses are felt more heavily by consumers compared to the much smaller losses obtained from credit card loans.
- Consumers also account less for negative changes to their perceived wealth much slower with high-interest loans than they would for the cheaper alternative for the same reason highlighted above.
- Such loans also allow consumers to allocate less money towards repayment in comparison to the refund of low-interest loans, which are usually fixed at larger sums and less flexible.
NEGATIVE PERCEPTION OF THE BANKING INDUSTRY
- Another factor that drives high-interest loan consumers is their negative perception of traditional banks and the banking industry.
- The number of unbanked and underbanked households in the US were 6.5% and 18%, respectively, as more households are obtaining high-interest loans from non-banking firms.
- Most people in this category do not have enough money to sustain a bank account, lack trust in banks, or have little to no confidence in the banking system (22%).
- This attitude towards banking may be driven by a previous banking crisis, privacy concerns (some consumers may not like to disclose too many financial details), or the belief that banks do not foster benign intentions.