OVERVIEW

•  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.

INTERTEMPORAL CONSIDERATIONS

• 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.

MENTAL ACCOUNTING

• 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.

QUICK PROCESSING

• High-interest loan contracts offer quick processing times, instant, and almost instant access to the loan.
• For payday loans, lenders typically approve loan applications almost instantly. The process does not require filling lengthy document and is quite simple and quick compared to conventional loans.
• Lenders take no more than one business day to provide funding and as little as one hour if the required details for the loan's approval are delivered quickly.
• Due to the competitive nature of the market, some lenders advertise and provide quick services to stay ahead.
• Credit card loans offer an even faster process as the funds are instantly disbursed. There is no application, processing, or waiting time in this case.

CONVENIENCE

• High-interest loan contracts are more comfortable to procure and are less stressful. For example, payday loan processing and interaction are typically carried out online, thus saving the consumer the time and stress involved in booking an appointment and meeting up with a loan officer.
• Payday loans can also be spent accordingly as the consumer sees fit, unlike more conventional loans that are taken for a specific reason. It requires minimal documentation and sometimes none at all.
• Credit card loans, on the other hand, come pre-approved and unsecured. As such, no documentation is required.

FEW REQUIREMENTS

• High-interest loans have only a few requirements.
• The requirements to obtain a payday loan are minimal, as proof of a stable income source alone can almost guarantee access to one. As such, a valid and consistent income source is the most crucial requirement of the process.
• Other prerequisites include an active checking account and permanent residency registration. The consumer must also be 18 years and above.
• Compared to traditional bank loans which require a good credit rating, consumers can access payday loans with bad credit, as lenders judge their decision on the consumer's current financial situation.
• For credit card loans, the consumers need only have a good repayment and credit history on the card. Such loans are also collateral-free.

RESEARCH STRATEGY

THEY ARE EXPENSIVE

• As the name suggests, high-interest loan contracts typically come with high repayment rates. Besides that, some high-interest loans such as credit card loans might cause the consumer to incur specific fees.
• Depending on the state, the interest on payday loans could be as high as 900%, and averaging at 400%. In comparison, traditional loans charge between 4%-36% on interest.
• In a 2017 nationwide survey conducted by Edelman Intelligence revealed that 51% of credit card loan consumers feel that high-interest rates are the most significant drawback of credit card usage. About 33% were concerned with the annual fees, and 31% by high-cost fees such as late fees.
• Meanwhile, credit card companies might charge higher for customers with poor credit or a history of late payments.
• Also, credit card issuing companies typically "include a range of fees as part of the cardholder agreement." Unsecured credit cards require consumers to pay application, membership, and set-up fees, as well as to create a balance before they can receive their cards.
• Other fees include cash advance, balance-transfer, late payment, and over-the-limit royalties. As such, going over the card limit or missing a loan repayment would typically add to the loan balance, while incurring interest on the extra balance.

CYCLE OF DEBT

• The high rates and ease of obtaining high-interest loans usually cause consumers to default on repayment/rollover a loan. Rolling over loans typically increases the time it takes to repay the loan as the loan value accumulates, sometimes adding months and years to the original payback date.
• Almost 25% of payday loan consumers borrow their loans more than nine times. As the consumer extends the credit, the payday lender includes additional fees that increase the out-of-pocket costs of taking the loan.
• "A large part of the profit made by the payday loan companies comes from consumers who cannot repay previous loans on the due date and therefore end up extending their loans. This results in more fees for the customer added on top of the original amount borrowed, which then can lead to extreme debt."
• Credit card loan contracts are easy to obtain, and consumers usually do not feel the negative emotions that accompany taking a traditional loan. As such, they typically end up spending more than they can afford. When credits are accrued to a point where the consumer is unable to pay the minimum debt, it initiates a cycle of late or missed payments.

CREDIT SCORE REDUCTION

• High-interest loan contracts usually do not help to build customer credit, and in some cases, it could harm the consumer's credit score.
• Payday loans typically do not report to credit bureaus. As such, they do not help to build credit scores. While some versions of payday loans in specific states allow consumers to utilize lower interest loans that could be paid for in installments and reported to credit bureaus, this option is hardly available, and there is little available information regarding the procedure.
• Just like medical debt, payday loans report the debt to credit bureaus if it is sent to collections. As such, they could serve to harm the consumer's credit score.
• Credit card issuers report account activity to credit bureaus. As such, the timeliness of credit card loan payments is very crucial because late payments would typically reduce the consumer's credit score.

RESEARCH STRATEGY