Why keeping up with the Joneses is costing us more than we think!
By Lee Travers
I have made it clear, in other posts, that I believe the onus is on financial institutions to work with those in debt. Now, I want to I delve into the psychology of debt and the psychological problems that can occur as a direct result of a person’s financial situation.
Even though we are advised to spend only what we can afford, in today’s society that is not always possible. Many households live from month-to-month, trying to make ends meet. Whilst inflation has gone up on an annual basis, salaries haven’t always kept up, so the average consumer has found themselves falling further and further behind; often turning to credit to survive.
The availability of credit at the point of purchase has increased the accessibility of consumer credit, as has the speed with which loan contracts are made
As a result of the gradual relaxation in credit controls in the late 1980s and early 1990s, the rise in consumer borrowing exploded in the UK between 1994 and 2004 - and has continued to grow exponentially. Whilst it was only banks who could offer unsecured loans in the past, we are now seeing the rise in pay-day loans, pawn brokering and even supermarkets offering loans
In addition, the availability of credit at the point of purchase has increased the accessibility of consumer credit, as has the speed with which loan contracts are made.
However, in addition to the economic factors, it is fair to say that there are also social and psychological factors that have led to higher levels of debt. These include - and are not restricted to - a lack of financial education and money management tools, as well as the behaviours learnt from our parents. This is shown in Howard Tokunaga's 1993 study, 'The Use and Abuse of Consumer Credit: Application of Psychological Theory and Research', which found that people's use of, and views on, credit correlated with their own ability to use credit successfully.
For many, being seen to have the latest gifts or gadgets boosts self-esteem and makes us feel like we’re keeping up with society. In reality, that latest phone, or those designer shoes, are probably on credit and the only thing we’re actually left with is a staggering amount of interest on our repayments
As well as this, there is also the sociological divide. I am sure you’re all familiar with the saying 'Keeping up with the Joneses'? For many, being seen to have the latest gifts or gadgets boosts self-esteem and makes us feel like we’re keeping up with society. In reality, that latest phone, or those designer shoes, are probably on credit and the only thing we’re actually left with is a staggering amount of interest on our repayments. A combination of these factors has led to spiraling debt problems in both the UK and USA.
According to the Money Charity, UK consumer debt stood at a staggering £1.516trn in 2017, meaning the average UK adult owes more than £30,000 - around 113.6% of average earnings.
The average UK adult owes more than £30,000 - around 113.6% of average earnings
The charity claims that the total credit card debt in November 2016 was £67.9bn. Per household, this is £2,465 – for a credit card bearing the average interest, it would take 25 years and 10 months to repay, if only minimum repayments were made each month.
For a credit card bearing the average interest, it would take 25 years and 10 months to repay, if only minimum repayments were made each month
Based on these figures, households in the UK would have paid an average of £1,866 in annual interest repayments.
This has resulted in the Citizens Advice Bureau in England and Wales dealing with 4,022 new debt problems every day during the quarter ending June 2016, with 248 people a day being declared insolvent or bankrupt. Homeowners have also faced losing their homes, with 15 properties being repossessed daily.
Statistics in America aren’t too different. According to Progressive Relief, over 40% of US families spend more than they earn. As a result, the average American has $8400 worth of credit card debt alone, meaning that if they were to make a 2% payment every month at an annual percentage rate (APR) of 15%, it would cost them almost double that - $13,000 - in interest and take them 30 years to pay off. This has resulted in almost one in every 100 households in the US turning to bankruptcy as a means of dealing with their financial troubles.
At an annual percentage rate (APR) of 15%, it would cost them almost double that - $13,000 - in interest and take them 30 years to pay off
Effect on mental health
Whilst the effect on people’s pockets may be shocking, it’s incredibly saddening to see the toll that this is taking on people’s mental health; something that is often overlooked.
The report from Progressive Relief shows that households which have outstanding credit, reported significantly lower levels of psychological well-being than those with no debt.
Another study, 'Psychological factors in consumer debt: Money management, economic socialization, and credit use' by Stephen E.G. Lea, Paul Webley and Catherine M. Walker found that the psychological cost associated with consumer credit culture in Britain need to be addressed by government policy, and should not just focus on the potential macroeconomic consequence of the rising levels of consumer indebtedness in the UK - but also consider the more general welfare effects of increased psychological distress amongst debtors.
Better money management
The question is: How do you help people to be better with their money? The study by Lea, Webley and Walker found that serious debtors often referred to themselves as having weak money management skills. Non-debtors, who were fortunate enough to have access to money management facilities such as a bank account, proved to have better control of their money.
Therefore, could it be argued that debt and lack of resources/opportunities - which are often as a result of poverty - go hand-in-hand; meaning that the poorest people in society are those that pay the highest cost? Or is it a case of prioritisation and careless spending?
The benefits of helping people to save
Households that said they put money into savings on a regular basis were found to be around 4% more likely to report complete psychological well-being than non-savers. However, the average person would need to either increase their annual salary by 7%, or their annual savings by 18%, in order to offset the psychological impacts of debt.
Households that said they put money into savings on a regular basis were found to be around 4% more likely to report complete psychological well-being than non-savers
What’s the answer?
In conclusion, when you analyse all of the evidence, it appears that debt is part of a wider pattern of dysfunctional economic behaviour. Contributing factors include: Learned behaviours from one's upbringing, weak money management and education and freely available, yet expensive, low status credit sources. These all result in poor money management; all of which has a negative impact on people’s mental health.
Results from the study by Lea, Webley and Walker suggest that avoidable failures of personal money management may be involved in some people's debt situation. Therefore, whilst it may be a tall order to eradicate poverty, to help people learn to manage money could be the solution to helping reduce the amount of debt in both the UK and US - working towards improving people’s mental health too. This is where my new business venture is looking to make a difference.
Let me introduce you to iam bank - a place where members use their spending behaviours to make their money go further; paying off their debts sooner and building their wealth and savings faster.
We at iam promise to deliver a new kind of bank, a better bank that challenges all those that have gone before it. iam will offer the world's first machine learning banking products - services that will continually adapt to member needs, providing unique, personalised experiences.
Through our own proprietary technology and that of our specialist global partners, iam will bring to market products tailored to members' spending habits, appetite to risk and savings goals. We will combine money, debt and investment management and, by doing so, improve the financial wellness of all those who choose to bank with us.
At iam, we believe that wellness goes beyond eating and exercise; that it is a way to live, a state of mind and that it is deeply impacted by the financial responsibilities we have and choices we make. iam was created, not just to provide people with a better way to bank, but to help people to bank better and live better, as a result.
As part of this, we will study the psychology of 'Red Letters' and how people's mental health is affected when they receive a debt letter. We will look at how creditors taking a different approach and working with those in debt to try and work through their financial situation, could benefit mental health in the long run.
To find out more, follow us on Twitter and LinkedIn. Or feel free to get in touch and I can tell you more.