I’ve been helping people with financial problems since 1994. My passion for assisting others with this struggle was because I lived through my own set of financial misery in 1989. After going through that process I was very depressed but also incredibly curious why my self-esteem had been so shattered along with my ability to make complex decisions and take action.
That experience has taken me on a long journey of assistance and research. One of the points of research that I participated in was the study of debt and depression. In that study, we found “nearly half of the people who have problems with debt are experiencing symptoms of depression.” In the general population depression was impacting 9.5 percent of the population but in those with financial problems, it was 49.3%. The majority of those reported being severely depressed. – Source
Psychologist Joe James said that as a result of the depression “People become emotionally paralyzed, which leads to the inability to develop a plan or take action and compounds their financial problems. This is why people who are having money troubles should get extensive professional help as soon as possible.”
While that is sound advice, what I have observed over the decades is people exercising poor judgment on the type of assistance they seek. Instead of best evaluating their circumstances, they leap at the first promising sales pitch they hear.
The debt relief world of providers and assistance is a crazy landscape. It ranges from exceptional individual debt coaches like Damon Day or Michael Bovee, to small companies that try hard, sales companies that hardly seem to try, to professionals like state licensed bankruptcy attorneys. In general, the mass market debt relief companies are the ones doing the advertising and closing as many sales as they can. Finding the gems in the dark mine is a rare find for most people.
Debt problems are generally a simple math problem wrapped in emotion and confused decision making. Behavioral economics plays a major role in dealing with debt as well. Here is an interview where I sat down with a leading expert in the field and discussed this subject.
The unconscious reasons why people make decisions when dealing with perceived financial problems is critical to understanding why people often make the wrong decisions for them.
A group of authors, at the University of San Diego School of Law, just published a research paper that does the best job I’ve seen in addressing the underlying issues that lead to this debt burden corrupted decision making.
While the paper was geared towards consumers pursuing high-cost credit and payday loans, the underlying issues are the same for the people who typically struggling with debt.
Shmuel I. Becher, Yuval Feldman, and Orly Lobel authored this excellent paper that should be mandatory reading to understand the hidden issues driving people in problem debt to make poor choices on how to deal with it.
The 31-page paper can be a bit overwhelming and not all of it applies to this discussion of why people make these bad get out of debt decisions. So I’ll pull out the best bits and share them with you below.
In the paper, the focus is the word poverty but my years of experience have shown a strong correlation between the state of poverty and the state of financial crisis. As you read through these quotes, please feel free to mentally replace “poverty” with “debt problems.”
“From a psychological perspective, poverty affects people’s economic choice patterns and decision-making processes. A growing body of literature suggests that people who face poverty are likely to make ill economic choices. Some of this literature indicates that it is not so much that bad choices lead people to poverty, but rather that poverty can lead people to make bad choices. Suboptimal behavior, in turn, can deepen poverty or perpetuate it.”
“From a cognitive perspective, immediate benefits or costs loom larger and disproportionately outweigh future ones. Therefore, people will also prefer immediate benefits even if these benefits will come at a greater cost in the future. The terms “myopia” and “time/hyperbolic discounting” also describe this kind of behavior. Put simply, myopic consumers “care more about the present and not enough about the future”. This effect is also related to people’s limited will power where people’s limited ability to delay their need to for immediate satisfaction is causing them to make repeated mistakes with regard to their economic choices.”
The Present Bias helps to frame why consumers will frequently leap at the first happy sales message from a debt relief company rather than contemplatively weigh the facts and future impact. I’ve written about the problems surrounding hyperbolic discounting.
(Behavioral) Economics of Information
“Standard economics posits that people are rational agents who base their beliefs, actions, and preferences on information. Information, therefore, can valuably enhance decision making and is essential for people to make well-informed choices.”
“The confirmation bias can explain why those consumers who do read disclosures and loan information are not likely to evaluate their content rationally. According to the confirmation bias, people process information in a way that strengthens their already existing viewpoints. Hence, even if consumers read information regarding their loans, they should not be expected to always evaluate such information objectively. As a result, a poor consumer who believes that expensive credit will end up improving her long-term financial situation is likely to over-value information that supports her desire/belief. At the same time, she is likely to ignore or discredit contradicting information or evidence that could have served as warning queues.”
In dealing with debt the most common confirmation bias seen is the incorrect belief that bankruptcy is a last resort or should be avoided. People then process all decisions against that bias rather than considering all solution on a factual basis.
“At times, financial information concerning debt is likely to threaten one’s beliefs and emotions, as well as require unattractive courses of action. Avoiding financial information is, therefore, a “common, pathological and detrimental approach that people adopt in relation to their finances and debt.” This entrenched behavior, which is difficult to overcome, deprives people of potentially valuable information. Naturally, such information can sometimes be imperative for good decision making and improving future behaviors.”
“Impulsive financial behavior and poor decisionmaking may, in fact, be the products of a persistent sense of scarcity. Marketers may recognize this reality and pray on the poor for certain services and products.”
“Scarcity is likely to make people myopic: it directs people to further focus on present needs and
overvalue immediate gains. Scarcity means that the mind is clouded and more prone to error.”
“Our attention, self-control and long-term planning abilities are bounded. Poverty means less cognitive bandwidth. The multiple disadvantages of poverty – including financial worries, time pressure, negative stereotypes, and emotional distress – tax cognitive capacities. This, in turn, can negatively affect the quality of judgements and decisions.”
That statement above is right on target. The pressure of the financial burden leads people to make poor decisions based on a number of factors not related to intelligence. Intelligent people make horrible decisions about how to deal with their debt all the time. Over the years I’ve had so many bank officers and financial professionals contact me for help. They actually understand the math but can’t see through the fog of decision making impairment.
“Overall, there is no evidence of significant difference in cognitive abilities of people with high and low incomes. However, if people were prompted to think about money worries before taking a fluid intelligence test, the subsequent scores of the low-income subjects dropped dramatically.”
Money worries impact clear thinking.
“This helps to explain why people in disadvantaged circumstances may make poorer decisions that at times seem irrational and counterproductive.”
“Furthermore, firms often tailor their tactics and marketing efforts to their target audience. Some firms have specialized in targeting and luring poor or vulnerable consumers; offering services and products such as payday loans, rent-to-own transactions and uninvited sales.”
“People rarely consider more than one option at a time – a behavior called “cognitive rigidity.” Cognitive rigidity “gets amplified when we feel threatened by time pressure, negative emotions, exhaustion, and other stressors.” But having a few options in mind is likely to yield a better decision.”
That option solution is why I built the Get Out of Debt Calculator to provide a quick look at options to deal with debt. It is interesting when people in debt and people in the debt relief space look at the overview chart I created, they disagree with it, always favoring their preconceived notations or products they sell.