
Why Don't People Manage Debt Better? - sergeant3
http://blogs.scientificamerican.com/mind-guest-blog/why-don-t-people-manage-debt-better/
======
imgabe
Anyone at a point where they are making monthly payments on multiple credit
cards has already lost the debt game. People don't manage debt better because
they have been marketed to and taught to use debt completely inappropriately.

Debt should be used to purchase an asset that will appreciate or otherwise
provide an income in excess of the interest payment on the debt. Full stop.
That is how businesses use debt and that is the only sensible strategy. As a
consumer, a house may be a sensible use of debt. A reliable car needed to get
to work may be a sensible use of debt. A student loan might as well. Carrying
a balance on a credit card is almost never an appropriate use of debt.

Unfortunately, marketers have instead convinced consumers that debt is an easy
way to buy things they can't afford and pay for it later. This is almost
always a losing proposition for the consumer, who invariably ends up paying
much more than they would have if they had just saved up and bought the thing
in full up front. The way to sensibly manage this is to not fall into the trap
in the first place.

~~~
bradleyjg
I don't think such an absolute position is warranted. It's true that saving up
for a big purchase will end up costing you less money than borrowing to pay
for it and paying it back. But you will have the item purchased for less time.

Suppose you have enough disposable income to pay for a new $1200 TV over the
course of 12 months. In scenario 1, you save $100 each month. The bank pays
you 0.5% interest. As of January 1st next year you'll have a new TV and $2.75.
In scenario 2, you put $1200 on a credit card with a 10% APR. You pay $100
each month towards the credit card bill. As of January 1st next year you have
a TV you've been watching for a year already and owe $69. You've essentially
paid $72 for the privilege of getting the TV you wanted a year earlier.

Is that worth it? Well that depends on a lot of things, some of them
intangible, but I wouldn't say it can't possibly make any sense. The sort of
Puritan attitude towards consumption and debt may not be the worst attitude to
have, at least for oneself. But when combined with evangelism it is pretty
annoying.

~~~
ac29
> Suppose you have enough disposable income to pay for a new $1200 TV over the
> course of 12 months. In scenario 1, you save $100 each month. The bank pays
> you 0.5% interest. As of January 1st next year you'll have a new TV and
> $2.75. In scenario 2, you put $1200 on a credit card with a 10% APR. You pay
> $100 each month towards the credit card bill. As of January 1st next year
> you have a TV you've been watching for a year already and owe $69. You've
> essentially paid $72 for the privilege of getting the TV you wanted a year
> earlier.

I think this is a good point, but the sort of people who would need a year to
save $1200 do not have the sort of credit to get a 10% APR credit card, APR's
closer to 20% or higher are more likely. Run the math again at 18% APR ($133
in interest over the 14-month payoff period) or even 24% ($185 in interest
over the 14-month payoff period), and you quickly see just how much premium it
costs to get that TV a year earlier.

I'm ignoring the negligible savings rate interest in your example and,
probably foolishly, assuming this hypothetical person only has this single CC
debt.

~~~
epimetheus
Actually, a lot of places constantly run "Zero Interest If Paid Off In 12
Months" deals all the time. Lowes, Furniture stores, and even some Credit
cards.

We've paid off Couches, A refrigerator, a new Sewer Drain, and several other
things (a nice Kitchen Table most recently) this way. It's not as good as
saving for it, and getting a few dollars of interest, but that's a marginal
gain anyway.

~~~
evunveot
The Amazon Prime Store Card is an example. You can choose per transaction
either 5% cash back or 6/12 (sometimes 24) months interest-free financing,
depending on the size of the purchase. (You can only use the card at Amazon,
though, and there's the Prime membership fee.) I've bought several plumbing
fixtures and a laptop without paying any interest this way.

~~~
padobson
This is effectively how the low fed-funds rate trickles down to the consumer -
there are 0% financing opportunities everywhere.

Ultimately, these deals are subsidized by people who get charged with massive
deferred interest payments because they don't plan properly, and that sucks
for them, but as you say, it's a great way to start experiencing the benefits
of a purchase instantly.

Even better is to use the financing opportunity on something that makes money.
I've furnished apartments using 0% financing, and I'll get anywhere from
50%-100% increase on rental income for a furnished apartment - while paying no
interest on the loan! It's like putting extra money in your pocket every month
for free.

~~~
forgetsusername
> _This is effectively how the low fed-funds rate trickles down to the
> consumer - there are 0% financing opportunities everywhere._

Indeed, and it's important to point this out to those who insist "Average Joe"
doesn't benefit.

Three of the largest investments people will make in their lives are 1) their
home, 2) their education and 3) their vehicle. All 3 are generally financed,
and financing rates are at historic lows.

~~~
maxxxxx
The prices of 1) and 2) are at historic highs though. Even if the interest
rate is low you still have a lot of debt to pay off.

------
kdamken
Better question: why do people buy things they can't afford and most often
don't need, putting themselves in this position?

So many of my peers don't make a lot of money, but then still go out and buy a
new or newish/used car and put themselves on a multiyear payment plan. "Oh but
it's only 200 a month, I can swing that". Repeat for like 3-4 other things and
suddenly they're always complaining they have no money and don't know why.

I highly recommend to anyone who's looking to take their financial situation
more seriously do two things:

1\. Read up on Mr. Money Mustache, a guy who managed to retire at 30. Even if
you don't plan to retire early, it's eye opening to realize you don't have to
spend your entire paycheck every month:
[http://www.mrmoneymustache.com/2013/02/22/getting-rich-
from-...](http://www.mrmoneymustache.com/2013/02/22/getting-rich-from-zero-to-
hero-in-one-blog-post/)

2\. Check out YNAB (You Need a Budget):
[https://www.youneedabudget.com/](https://www.youneedabudget.com/). Takes a
little work to start using, but once you do, you'll understand your money in a
way you never thought possible.

~~~
RUG3Y
Mr. Money Mustache is pretty awesome but the guy had a very highly paid job
that allowed him to retire early. Some of us are fiscally responsible and
don't make all that much cash - I find that a lot of his advice is fairly
useless unless you have some money to begin with.

~~~
kdamken
I'd disagree on that last part - I'd say that if you're not making a crazy
salary his advice is even more valuable. Most people spend an obscene amount
of money on things they don't actually really need. Some classic examples:

A $3 coffee everyday adds up to about $90 a month, when you can usually just
drink free coffee from your office or buy some cheap pre-ground stuff.

Spending $5-6 for lunch each day at work can easily add up to another $100+
dollars a month, when you could just make a bunch of peanut butter and jelly
sandwiches and spend a fraction of that.

So there's close to $200 a month, right there.

If you're trying to retire early, it's definitely way tougher on a lower
salary. But improving your spending habits is an important skill for everyone,
especially for those making less.

~~~
charlesdm
This is the best way to get depressed. It's always significantly easier to
negotiate a $1k raise than it is to reduce your spending on basic stuff by
$1k.

Focus on earning more, not saving (on useless expenses).

~~~
kdamken
I like buying stuff as much as the next guy, but if not buying things you
don't need would make you depressed, you probably have deeper issues that need
addressing.

~~~
charlesdm
If you want to save money, do it on large purchases. Buying a $30k car?
Negotiate aggressively so you can buy it for $23-25k. Anything above a few
$100 is worth haggling over.

Do you know how many people pay the listing price of a car, yet cut coupons to
save a few euros/dollars? A lot. It's ridiculous.

Some of the joys in life are simple things, such as drinking a $2-3 coffee or
having a cocktail in a nice bar, etc.

~~~
Ocerge
Absolutely. I fully recognize my $2.50 americano every morning could be a
couple of cups of free office coffee, but I look forward to it every single
day. I also drive a 10-year-old but reliable car, so I don't have any huge
monthly expenditures outside of rent and my $150 student loan payment. I'll
take the $100 or so hit every month in exchange for me starting my mornings on
a positive note. It's not going to positively change my life enough to not
have that americano every morning.

~~~
kdamken
Playing devils advocate here: you're spending $1200 a year on coffee. With
that money you could not only buy a really nice coffee machine and make it
yourself every morning, but also have a bunch of money leftover to put towards
your loans, invest, put towards a nice vacation, etc.

The idea is that those small daily expenses tend to add up, and there may be a
lot more of them than you realized.

~~~
billmalarky
Reminds me of the old joke:

"If you had stopped smoking 10 years ago you could afford to be driving around
in a Ferrari right now."

"Do you smoke?"

"No."

"Then where's your Ferrari?"

Point is don't sweat the small things. Sure they add up, but you should
dedicate a portion of your cash flow towards investments at the start of the
pay cycle, not "what's left at the end." Then the rest can be spent on
anything arbitrarily with a clear conscious.

------
clarkevans
When a late payment is $39.99 and a mark on your credit record, even the
smallest, lowest-interest debts become high-risk. Reducing the number of risks
(and mental energy managing them) easily outweighs the interest differences.

When you have to spend a 1/2 day to refinance a credit-card to an unsecured
personal loan, it's not always a clear win: you might not get the loan, or the
loan offered might have significantly higher interest rate than advertised,
etc.

~~~
CPLX
Exactly. Every small balance is a potential disaster in the making, an autopay
that inexplicably fails, a teaser interest rate that expires, an unexpected
annual fee or recurring charge from a merchant, a supremely annoying hour on
the phone, etc. I had the exact same reaction to that part as you did. If
you're going to evaluate economic actors for rationality you have to make sure
your assumptions of what's rational are well grounded first.

~~~
xivzgrev
I agree. I find my self doing this often with to do lists. Knock off quick and
easy stuff so i feel like im making headway even if its not the most important
/ impactful. I find that more tempting in personal than work where i am only
accountable to My self. So I can definitely to the "irrational" people in
here, it's not so irrational when you think about all the consequences.

------
pilom
This is showing that the Dave Ramsey "debt snowball" (pay off smallest debts
first to get a psychological win and some breathing room by having fewer
minimum payments) is a more effective way to get people to pay off many
separate debts than paying off "highest interest rate first" even if it is
less optimal for a rational actor. Just another case of people aren't 100%
rational that many people have known for a while.

~~~
DannoHung
I have literally have people tell me that this is still rationality because
it's the rational thing "for them". Like, the weirdest one was a cognitive
psychology doctoral student.

I mean, okay, if you can redefine rationality to be completely subjective,
then sure, rationality is flargikriggendurf.

~~~
jerf
In addition to the other fine replies, let me point out that "humans are
irrational" is the negation of a very small point. It allows us to think we
know something, when in fact what that statement tells us is only that we _don
't_ know something about human behavior. It is logically much like saying
"Humans are not 7-year-old bulldogs named Fido living in New Jersey on the
second floor of a shared house." It's a true statement, but carries virtually
no information because it only identifies an incredible small, precise part of
the possibility space and negates it; it does not, on it's own, tell you much
about what humans _are_.

Humans are not merely "irrational", they positively behave and think in very
specific ways. No human is immune to this. It is, therefore, perfectly
rational to discuss rational ways of managing the _specific_ human behaviors
that lead to irrational behaviors.

This is also while ritual denunciations of "homo economicus" are really quite
sophomoric... the nonexistence of rational economic actors does not mean that
you can simply model humans in whatever way you please to make your
preconceived notions work. It means that you've got to go _learn_ what humans
_actually do_ , which is going to be very challenging, and take that into
account, which is almost certainly going to shock anyone who tries it. It
means the problem is suddenly immensely _harder_ , not easier.

~~~
eli_gottlieb
>This is also while ritual denunciations of "homo economicus" are really quite
sophomoric...

Admittedly, this is because "homo economicus" is sophomoric in the first
place: it proposes an actor who has no computational or informational bounds
and sees the world only in terms of a single real-valued variable called
"utility", which is generally constrained only to be any monotonic, continuous
function of their monetary net worth. This actor then optimizes expected
utility with no regards to modeling causal structure _or_ to which observables
are actually ergodic.

No such creature ever has, or in fact ever _can_ , exist in the real world. In
limited domains where ergodicity holds, computational needs are few, and small
sample sizes can yield very good inferences, we can do thought experiments
about what such a creature _would_ do, and act according to those if we
please. But holding that such behavior is the _normatively correct_ way to act
when it's actually _impossible_ is the kind of religious thinking one gets
when composing "normative theories" without experimental basis.

------
breischl
The article ignored the completely rational reason to pay off small debts
first - increased liquidity.

By paying off small debts first you can reduce the amount of money you have to
come up with each month. If you have any uncertainty around income or other
expenses, there is real value in that.

Doubly so for debts that could be foreclosed on - if you prepay your mortgage
a bunch and then fall behind and get foreclosed on, all that prepayment is
just cash down the drain. If you had completely paid down some smaller debts
instead, you would be in a better position.

Basically, paying down higher-interest debt first is optimal only if you're
certain that you'll never default on anything.

~~~
bbcbasic
Good point. Also, at least in my county a bank may look at limit of the credit
card rather than the actual borrowings when deciding whether to give someone a
new loan (say a mortgage). So if you have a couple of 10k credit cards, and
one has $200 owing you can just pay it off and cancel the card, and
potentially could be the difference between getting a home loan or not. Again
this is along the lines of increased liquidity.

------
Spooky23
If all things were equal, and your repayment terms were a fixed artifact, the
strategy assumed to be optimal in the article would be correct -- it would
make more sense to focus on the higher interest rate to avoid accruing
interest. But they aren't.

Credit cards in particular are tough -- if you have alot of debt and credit
lines and don't make significant impact on principal, they start cutting
credit limits, which incurs fees. Interest on fees and fees have payment
precedence over regular interest and principal, so it starts a vicious cycle.
You end up in a situation where the banks assume you will default, so to
compel you to pay more to _them_ , the credit card will drop your limits to
trail your balance.

So you really have two priorities: paying down debt and maintaining credit
lines to avoid capricious changes in your payment terms.

When you have lots of credit lines, minimum payments start to matter alot, as
they sap your re-payment power. If you focus on closing the smaller accounts
and walk your payment focus up the stack, you'll be able to make more
significant payments and stay afloat. When you make alot of progress, you have
a higher likelihood of refinancing the bigger debts, which is ultimately where
you save on the high-interest accounts.

------
danjayh
I find myself a bit bemused that the article specifically mentions student
debt as an example of something that people can refinance but don't. I hadn't
ever had any student debt until marriage, but since then (and until recently)
my wife and I have been working through a great deal of it together.

As someone who has worked through paying down a large amount of student debt,
I can tell you that student debt is _very_ difficult to refinance. Our student
debt balance was much higher than the median, but I believe that our
experience with refinancing _was_ very typical: we couldn't refinance our
student debt at an interest rate that was even remotely attractive.

We reacted to the dearth of refinancing options by deciding to eliminate our
debt as quickly as possible, and when we first got married we dumped about
$35k into debt reduction. We chose to go after the high interest rate first,
which was also the largest loan. Had we gone after the smallest loans first we
could have paid off several of them instead of merely making a (significant)
dent in the higher rate loans, and this is where the psychology comes in.

Dumping a ton of money into a debt without changing anything but your
principle balance is _discouraging_. It was for us, and it is for nearly
everyone else too. Personal finance counselors like Dave Ramsey actually
instruct people to intentionally pursue the smallest debts first because the
feeling of momentum helps most people to maintain dedication to getting out of
debt, which in many cases will more than offset the difference in interest
rates (paying down faster due to more resolve = less interest overall). We
sold stuff and skimped like crazy people and we killed our debt, but it's a
very common thing for people to run out of determination before they run out
of debt. Since that's such a common problem, I'd say that it's not necessarily
a bad thing that people pay debt in a _financially_ non-optimal way if the
method is at least _psychologically_ optimized.

------
carsongross
I used to think that the medieval western distrust of usury was backwards and
foolish.

Then I read about the roman experience with debt, and now I am far less sure
of that.

~~~
navait
Is there a book/article you'd recommend?

~~~
carsongross
Without endorsing all the ideas in them, here are two interesting books:

[https://en.wikipedia.org/wiki/Debt:_The_First_5000_Years](https://en.wikipedia.org/wiki/Debt:_The_First_5000_Years)

[https://en.wikipedia.org/wiki/The_Law_of_Civilization_and_De...](https://en.wikipedia.org/wiki/The_Law_of_Civilization_and_Decay)

------
bcheung
There's an important factor that is ignored by the article and it is a
fundamental principle in finance. That principle is risk.

Any time anyone asks a question in finance the correct answer is always, "It
depends".

Absolute answers like always pay highest interest card make sense
mathematically in certain cases but they are not the whole story and don't
take into account other factors that are equally if not more important than
paying the least amount of interest.

Another factor to consider is cash flow.

If you are someone that lives paycheck to paycheck and can pay off a card or
loan sooner to create some additional cash flow that has major benefits for
increasing cash flow, peace of mind, and providing a buffer for unexpected
expenses.

It lowers the risk of default and late payment fees / increased rates if you
have more cash flow. Ultimately leading to paying less in interest and fees.

If there are unexpected expenses you will be glad to have the available cash.
That's worth paying a little more interest in the long run.

There's also the fact that it may not make sense to pay down low interest
rates like a 4% fixed mortgage when you can invest at rates higher that. In
that case you want to pay it off as little as possible and maybe even take out
equity to put into investments.

------
mark_l_watson
I have so many friends, and some family members, who act as though the optimum
life strategy is to buy as much material stuff as they can without getting
into a default situation. Given a lifetime exposure to marketing I don't much
blaim their attitude.

The thing is: the idea of maximizing material success is so very wrong. A good
life is about experiences, not material stuff. Having savings and flexibility
that entails makes life more relaxing and pleasure full.

~~~
bcheung
It's subjective to the individual. It may be wrong to you but to them you're
the one that is the fool for not enjoying life to its fullest.

Some people are motivated by taking trips, others by the big house. Personally
I don't care for traveling and find it boring and at best a hassle. I would
much rather have the bigger house.

People have different risk profiles and needs for material possession. Some
people rather have peace of mind, others don't really care and rather have
material comfort.

I think the important thing is not to judge people based on what is important
to them. Just because it is not what you think is important doesn't make it
wrong.

~~~
mark_l_watson
I agree with you. I meant to be talk about my own preferences, rather than
lecture other people what to do.

------
jakub_g
A big part of Daniel Kahneman's "Thinking. Fast and Slow" is devoted to
economic behavior and in general, people are not rational when it comes to
money - in some cases risk averse, in other risk seeking. He explains a lot of
studies on the topic. If you have some spare time, I recommend the book
(though it's not an easy read, as it's very information-dense).

~~~
jmckib
I've been meaning to read that. Did you end up getting anything practical out
of it?

~~~
ibero
there are a lot of small near-practical applications, but it all really
revolves around trying to be cognizant that our initial impressions/estimates
vary wildly and are biased.

The book spends the entire time giving you countless examples to hammer the
point home.

My favorite example from the book (via wikipedia)

 _Linda is 31 years old, single, outspoken, and very bright. She majored in
philosophy. As a student, she was deeply concerned with issues of
discrimination and social justice, and also participated in anti-nuclear
demonstrations._

 _Which is more probable?_

 _a) Linda is a bank teller._

 _b) Linda is a bank teller and is active in the feminist movement._

[https://en.wikipedia.org/wiki/Conjunction_fallacy](https://en.wikipedia.org/wiki/Conjunction_fallacy)

~~~
bcheung
:D

I skimmed through a little bit of that book and that is one of the ones I
remember seeing that was very interesting. I should finish reading through it.

------
alexashka
We all know why people don't manage debt, health, relationships and everything
else better.

Because they're dumb :)

Debt is just another tool the folks in power have to exploit the poor.

When you have 100 mil, you can hire a smart person to take advantage of debt.

When you have 100 dollars and you live around other people who have 100
dollars, you know what happens, you're the one being taken advantage of.

Everything else is talk.

ps. I am just starting to not be dumb and I'm almost 30 and I've had a ton of
support and luck go my way. Most people will hopelessly get exploited and
spend their days coping. Just have a look around - don't believe the 'hi how
are you' smiling faces, they're pretending and you know it ;)

------
gspetr
"The greatest shortcoming of the human race is our inability to understand the
exponential function." \--Albert Allen Bartlett

Considering that 97% of the survey participants allocated their debt payments
in financially suboptimal ways, perhaps the second greatest shortcoming of the
human race is our inability to understand the compound interest.

"Put God in your debt. Every stroke shall be repaid. The longer the payment is
withholden, the better for you; for compound interest on compound interest is
the rate and usage of this exchequer."

\--Ralph Waldo Emerson, Compensation,' Essays, First Series (1841)

~~~
pc86
Paying off debt in the way that saves you the most interest over multi-year
timeframes may be optimal financially but is not necessarily optimal
psychologically or logistically.

If you've got a 2% debt you can pay off in 6 months to open up $200/mo in cash
flow that may be better psychologically than plugging away at $80k in student
loans that are 4/5/6%. Yes 50 years from now you will have slightly less
money. Suboptimal does _not_ mean wrong.

------
rconti
The more time a person spends analyzing their debts and trying to find the
optimal repayment or refinancing strategy also brings the unpleasant debt to
the foreground. I think people prefer to pretend that it's not even there. It
hurts them financially in the long run, but avoids confronting a painful
reality.

When I got out of college, I had some debts to repay (car loan, credit cards,
student loans). Someone who I thought was a friend ended up bringing her
manager with her to hard sell me on starting a retirement account with them.

Partially because I was stubborn and annoyed at being tricked into the sales
call, I simply stonewalled for 3 painful hours. I tried to be nice (I suppose
I am too nice), so I didn't kick them out. I simply kept insisting that I was
better off putting $0 into investments until my higher interest debts were
paid off. They pulled out a bunch of lines about "starting a pattern of
saving" and so on, that are definitely correct on some level, but I stood by
the math.

Eventually they got the memo, and left. Once my debts were paid off, I started
putting money towards my 401k and short term savings. Every time I've gotten a
raise or a big bump from switching jobs over the past 10 years, virtually
every additional dime has gone into savings.

Have good principles. Then stick by your principles.

------
CPLX
This article makes much of rationality, but the concept of a rational actor in
economic terms is really way more complicated and sophisticated than these
sorts of analyses. So much so that it's possible to argue that there is no
such thing as an objectively defined rational actor at all.

To do my best to shorthand the issue, assume that a rational actor is defined
as someone who takes the course of action presumed to have the greatest
likelihood of a positive (or the most positive) outcome. In order to evaluate
their current strategy for rationality you have to have forward looking
prescience to determine if the strategy is in fact the most probable to lead
to the desired outcome.

This runs headlong into the issue of uncertainty, familiar stuff like
sensitive dependence on initial conditions or just simple complexity.

For a thought experiment, consider a game such as chess. The game is
completely discrete, all possible game states can be easily defined, the rules
are known, and there is no element of random chance or rules changing during
the game.

Nonetheless, the idea that you can put an average person in front of a chess
board and say "OK, play rationally" and expect everyone to cheerfully plot out
the exact same sequence of moves is obviously ludicrous. There are too many
possible outcomes and threads to reason about fully, there are competing
priorities in any strategy, etc.

Then when confronting an economic system that is certainly as or more complex
than a simple game of chess, we expect rational economic decisions to be an
objective truth?

------
k__
I had a single mother and she had 3 bank accounts, all about 500-1000€ in the
red for most of my childhood. This made me rather adverse to taking credits.

I only took one, for paying study fees. And it was "only" about 4000€ which I
paid back one year after getting my first job.

After that I always tried to have enough savings to live from for a year.

------
mixmastamyk
I've never needed or carried any debt my whole life, unless trying to build
some credit on purpose when I was younger. But, "unfortunately" my car is in
great condition and over 10 years old. I have zero need for a new car as I
work remotely and live in a walkable neighborhood with metro and uber, et al.

But beware: Credit expires after 10 years! I didn't know that. You wouldn't
believe the hell we had to go thru last time we moved. Trying to get a
landlord to accept a tenant with "no credit" was like pulling teeth.

------
lithander
Wow, this is mind blowing. 10% interest rates are really, really high in the
current state of economy - they don't become a great deal just because there
are credit cards with even worse conditions. I don't have a problem with
borrowing money when I need it. I'm indebted for the years to come because I
needed a 200k loan to buy a house. But that's okay because I'm paying 1.2% APR
on it. This is far less money than I would have to pay to rent a house so it's
a great deal. I've not even used all the cash I have when buying it because
some of it yields higher (guaranteed) interests then what I pay for the loan.
So there's still a lot of wiggle room for emergencies. And this is the first
time that I hear that you need to have a history of loans to get large loans.
What a devious system... I have a VISA credit card too, because it's
convenient to pay with, but I don't pay any interest on it. I just pay a flat
fee per year for the service and they settle the balance each month by direct
debit authorization. (Sorry for the bad english)

------
melted
Easy: there's a saying, you borrow somebody else's money for a time, but pay
back your own and for good. So paying off debts is inherently a much less
pleasant activity, which people want to avoid thinking about. Combine that
with the complexity a typical financial arrangement entails, and peoples
inability to comprehend basic math, and you can see why they don't manage
their debt better.

------
kamaal
Debt is basically an illusion that you owe money in the future. And people
commit things for the future without thinking about the consequences. Its
always easier to commit to eat healthy food next week, or planning to go to
gym next year- But doing them in the present is what is difficult. For the
very same reasons people are bad at saving and investments. They think they
have a lot of time in the future, so they might as well splurge a little
today.

From that perspective, you always feel you have time to buy a home, or start
saving for a personal retirement fund. Or time to pay off your credit card
bills, or the illusion that you borrow money for luxury today and defer it for
the future.

As time passes and you become more cognizant of the fact that your energy
levels and motivation to commit to large financial slogs like a house or a
retirement fund are wearing thin, you just think you should've started being a
little disciplined long back.

------
Wonderdonkey
Paying off small debts first isn't just a "natural tendency." Consumer advice
sites actually encourage this as a motivational strategy. Every single one of
them.

Having read this, now I question the objectivity of those types of advice
pieces.

For example, here's a story on US News that covers three strategies for paying
off credit card debt. The first tip is to pay off higher interest cards. But
the second is to pay off the smallest debts first and pay the minimum on the
other cards. What?!?

[http://money.usnews.com/money/personal-
finance/articles/2014...](http://money.usnews.com/money/personal-
finance/articles/2014/10/20/3-strategies-to-pay-off-your-credit-cards)

This "3 strategies" thing is very widespread, and all of the sites are the
same, from bank sites to credit recovery sites to financial reporting in
magazines and newspapers. The first that's presented always sounds complicated
(calculate bla bla bla). The second strategy is always "pay smallest debt
first." Nice and simple. If both are presented as good strategies, which do
you choose? The one that requires work, or the one that seems simple?

I used to read these types of advice pieces when I had high debt following a
layoff in 2002. I've recovered since then (paid off $65k in debt all at once
with a cash out on my house, thus avoiding bankruptcy). And now the No. 1 rule
is do not use credit cards to pay for things you can't afford. Use them only
as a tool to stay on the grid so that you have a good credit rating so that
you get better deals on everything that involves looking up your credit
rating. (You'll get a lower price on a car, for example, if you have a better
credit rating.) So take out a couple cards; make small purchases; auto-pay on
a regular schedule. (Do not change you payment schedule or make extra
payments. Some credit reporting agencies lower your score when you do this.)

~~~
Jtsummers
Not all articles on this are so clear, but at least this US News one is:

The optimal (highest rate first) approach is a slow slog that can be
discouraging and result in relapses. The sub-optimal (smallest debt first)
approach shows progress much faster, and if paired with the snowball approach
(as debts are paid off, freed cash goes to the next debt), it creates the
illusion (until high value debts are all that remain) of fast progress. It's
_psychologically_ easier to stick with.

> But the second is to pay off the smallest debts first and pay the minimum on
> the other cards. What?!?

Again, this article in particular, but the actual recommendation is to pay _at
least_ the minimum, which is not the same.

------
m1n1
Here's another debt choice: given a mortgage with over 20 years left on the
term and a sudden cash windfall of, say, 20% of the remaining principal, and
assuming there's nothing better to do with the money than applying it to the
mortgage would you rather (1) pay off some principal now thus effectively
shortening the term but allowing the monthly bill to stay constant or (2) re-
cast the loan by paying off some principal, still have 20 years left of
payments, but each monthly bill is now smaller? ... Personally I'd opt for (2)
because it immediately gives more breathing room especially if something bad
were to happen. Going with (1) may save more money ultimately, but doesn't
reduce the financial risk until the final payment is made.

------
JustSomeNobody
He how goes out owing the most wins. He's lived like a king and didn't pay for
anything.

But seriously, every article I read on personal debt talks about how to get
out of it after the fact. I think we need to do a better job of educating
people on this subject BEFORE they get into debt.

~~~
3dk
Agreed. Public schooling in most places completely fails at teaching the
general population how to plan for their future and learn basic financial
responsibility. A first step would be to show students what sort of options
will be available to them and what consequences of each option could entail.

------
orionblastar
I used to manage debt and save money until I got too sick to work and ended up
on disability. NO my wife and son and I live paycheck to paycheck and had to
file bankruptcy chapter 13 due to medical debt. If I didn't get sick I'd be
managing my debt better. Even with health insurance you can still rack up a
lot of debt and go over your head.

I worry that one day we might lose the house and end up homeless. I am not
medically cleared to work, and trying to find work as a freelancer when you
are disabled is really hard to do. Can't get a 9 to 5 job either. I have a
mental illness and medicine that threats it that makes me drowsy and hard to
focus and concentrate. I can't even drive a car anymore.

------
mdorazio
Good article and interesting study with multiple psychological inputs. I think
debt in general is difficult to process mentally because "negative" money is
quite different than "positive" money. Money that you have can be visualized -
you can spend it or even pull it all out in cash and see exactly how much it
is and how it grows or shrinks. Debt is purely a number on piece of paper or a
screen. You can't "run out" of debt or go to the bank and get your debt in
negative dollars. So without paying careful attention to financial rules like
compound interest, dealing with debt is something that humans just aren't
inherently very good at.

------
jonesb6
We have an entire generation growing up with the idea that large debt is
natural and acceptable. I've had countless friends go down $10,000 in debt and
say "what's $20,000 in debt really?" and it's a vicious cycle from there.

~~~
duderific
Yep - and they probably got there eating out a lot, opening a tab at the bar,
buying the latest and greatest electronics, traveling etc. There is no concept
of living within your means.

~~~
jonesb6
Honestly I think most of the things you mentioned are completely do able and
can improve quality of life enough to justify the expense.

Overpriced car straight out of undergrad? That's a different story entirely.
Those things could anchor an air craft carrier.

------
swehner
Even professional economists struggle to understand the exponential function.

~~~
tonyedgecombe
Professional economists struggle to understand economics.

------
dpierce9
One wrinkle here is that some debts have variable rates. For instance, if you
have a balance with a 3% variable rate and one with a 5% fixed rate, but you
are in a rising interest rate environment, the 5% fixed rate loan is
effectively a hedge on the 3% loan. It drags up your effective loan rate while
interest rates are lower than 5% but it lowers your effective rate if rates
rise above 5%. You can determine whether this is a valuable hedge by
estimating the likelihood of rates exceeding 5% long enough to make exceed the
cost of the hedge.

~~~
greenleafjacob
Wouldn't this depend on how frequently it's capitalized? If it's continuous or
even monthly it's better to just look at the APR.

------
eli_gottlieb
Because they don't have any money to pay it off with. Sometimes the simplest,
most obvious explanation is the most correct.

------
hcmag
Could someone well-versed with bankruptcy please explain the pros/cons of
going that route? I have heard that credit card debt is essentially free money
because filing for bankruptcy will wipe out all the debt.

If you already own a home/car, and have no intention of getting a loan in the
next 10 years, what is wrong with this strategy?

~~~
remyp
A pesky thing called morality and the fact that incurring debt with the
intention of later going bankrupt is fraud?

~~~
tamana
Don't be moral with corporations that have no intention of being moral with
you. The National Mortgage Foundation defaulted on its own mortgage!

~~~
tunesmith
> Don't be moral with corporations that have no intention of being moral with
> you.

Why not? Seriously.

------
spdionis
It's interesting to think that somehow I am better off than most americans
living in a third qorld country even if most have at least 5x my income just
because I don't have any debt.

We don't have credit cards with higher than 0 credit limit here. Those credit
lines sound very generous to me.

------
Mz
"Managing debt" is an oxymoron. You have to manage your _life_ better in order
to reduce debt. Most things that talk about debt or money management or
budgeting talk about it like it is a math problem. It isn't. It runs a lot
deeper than that.

------
PaulHoule
What is scary is that "how to manage money" is secondary to "how to manage
debt". For the most part I have thought about my bank balance first and
figured that my credit score would take care of itself and that has generally
been the case.

------
larryla
Same reason people don't manage their weight better; the bad behavior is
instantaneous and easy, the good decisions are extremely lengthy and
difficult.

------
blahdeeblah
Color me shocked that most MBA students don't have enough math skills to
intuitively choose an optimal payoff strategy.

------
brightball
There are a number of factors in the way that people manage debt payments that
the article seems to question as illogical.

Just take a standard setup of a mortgage where we'll give a generous 7%
interest rate, along with a couple of credit cards with a 15% rate and let's
put some decent sized balances here for sake of comparison:

$300,000 mortgage @ 7% over 30 years $10,000 credit card @ 15% $20,000 credit
card @ 15%

This is a random hypothetical with numbers made up out of thin air and without
factoring in tax deductions. From a sheer cash flow perspective, say you have
$4,000 to apply to your payments and the minimum payments are something like:

$2,500 for the mortgage $300 for the first credit card $500 for the second
credit card

So you've got a total of $3,300 in payments with an extra $700 to use to
accelerate payments that you've got to decide how to allocate between them.

If I apply it to the mortgage, this would be how the payment structure pans
out over time (using Debt Repayment calculator)

$300,000 at 7% with payment $2,500 = 208 months or 11.4 years to payoff with
$212,241.36 in interest (total paid $512,241.36)

$10,000 at 15% with payment $300 = 44 months or 3.5 years to payoff with
$2,983.59 in interest (total paid $12,983.59)

$20,000 at 15% with payment $500 = 57 months or 4.75 years to payoff with
$7,802.46 in interest (total paid $27,802.46)

Now, let's look at two strategies to applying the extra $700 cash with the
mortgage vs the small debts.

First the mortgage way:

$300,000 at $3,200 = 137 months or 11.4 years to payoff with $184,138.98 in
interest (total paid $484,138.98) $10,000 at $300 = 44 months or 3.5 years to
payoff with $2,983.59 in interest (total paid $12,983.59) $20,000 at $500 = 57
months or 4.75 years to payoff with $7,802.46 in interest (total paid
$27,802.46)

Now the smallest debt way:

$10,000 at $1000 = 12 months years to payoff with $1,354.08 in interest (total
paid $11,354.08)

But now our formula changes because after 12 months, I now have $1,000 to
apply to the next smallest:

$20,000 at $500 for 1 year (total interest $1,642.62, principle paid
$4,357.38) $15,642.62 remaining principle then at $1,500 after one year = 12
more months to payoff (24 months total) with $2,091.00 in interest (total paid
$23,733.62)

And now after 24 months I have $1,500 to apply to the mortgage.

$300,000 at $2,500 for 24 months (total interest $24,489.39, principle paid
$35,510.61) and then at $4,000 after that on the remaining $264489.39 = 86
more months to payoff with $107,086.21 in interest (total paid $442,597)

When you factor in cash flow into a total debt payment allowance you end up
with an increase in applied payment if you payoff the small stuff first. The
result here is a total net payment of $477,684.70 and no debt after 110 months
or 9.16 years vs a total net payment of $524,925.03 and continual debt
payments for 11.4 years.

EDIT: I need to go back in and adjust the mortgage way to accelerate payments
more when the 2 credit cards are paid off. My bad.

------
anon4
Don't fall into debt. If you must fall into debt, then do so to a friend at no
interest. If you still have to fall into debt, do so to a reputable bank and
pay it off as quick as you can - sell whatever assets you have if you must.

This of course applies to private individuals, not companies, banks or other
institutions.

~~~
maxxxxx
I would advise people not to lend money to friends and family. I have done it
several times and every time it led to problems and a lot of pain.

~~~
JoeAltmaier
Giving money, that can work. With a glad heart.

~~~
tamana
People won't accept gifts. Give a "loan" but treat it like a gift --never
mention the balance ask for the repayments.

~~~
maxxxxx
From my experience even that doesn't work. People will feel guilty about not
paying and resent you even if you stay quiet. But they also won't pay. At
least that's my experience with two members of family and one business
partner.

~~~
fluxquanta
Agreed. I have a sister who every year around Christmas, like clockwork, begs
for a "loan" with the promise of "I'll pay you back with my tax refund". Many
years and thousands of dollars later, in 2015 I finally said no. We no longer
speak to each other, and I was publicly (via Facebook) labeled the ungrateful
brother who only thinks of himself.

