The amount and rate at which people in the West borrow money has been increasing at a notable rate. This is in part due to the normalization of borrowing and debt as concepts through several pervasive loans, such as those to fund university education or the purchase of a home. Although attitudes towards indebtedness vary by demographic and by era, as seen in the wake of the Great Depression of the 1930s and the Great Recession (2007-2012), it is undeniable that borrowing behaviour has changed irrevocably over the course of the latter half of the 20th century and into the 21st. However, not all borrow in the same manner, or at the same amounts, and not all are capable of paying those loans off. This article will attempt provide an up-to-date survey of the literature surrounding how psychosocial factors affect borrowing behaviour. The article will begin at a social level of analysis and then narrow down to the attitudes of the individual and then to the cognitive processes undergirding these behaviours.
Societal norms regarding indebtedness have changed notably in the past few decades, and it is increasingly permissible to carry high levels of debt (Nofsinger, 2012). This has been accompanied by the lowering of the minimum downpayment amounts from 20% before 1956 down to 3% (Green & Wachter, 2005), allowing for households to put down smaller sums of their own savings to accrue larger amounts of debt. Naturally associated with this, Brinig & Buckley (1998) argue, norms regarding bankruptcy shifted to lose much of their stigma. While economic depression and hardship does seem to hamper borrowing behaviour, generations growing up once the hardship abates slowly but steadily become accustomed to and accepting of higher levels of debt. Nofsinger (2012) notes that in the United States, from 2000 to 2007, household debt rose dramatically from $7 trillion to $13.6 trillion, which he notes was fostered by government policy as debt spending helped grow the US economy from $10 trillion to $14.3 trillion. Although immediately after the Great Recession households seemed to focus on saving and paying off their debt, the general culture seems to have shifted radically and irrevocably.
The societal acceptance of higher levels of debt seem to be interestingly pooled in certain subpopulations. Research by Lea, Webley & Levine (1993) investigates, in part, the likelihood of knowing others who are indebted when one’s own levels of indebtedness is considered. Their results indicate that there is much social support and sympathy towards indebtedness among debtors, and these individuals were much more likely to know other individuals and families in the same financial situation, and less likely to assume others would disapprove of their own debts. The authors argue that since high levels of indebtedness arise out of economic hardship, individuals who have considerable amounts of debt are more likely to know others in similar situations, to understand and sympathise with them, amplifying the aforementioned trend in smaller circles.
In contrast to social acceptance, which passively renders indebtedness as being a normal and accepted, if painful part of life, social comparison potentially spurs on indebtedness by exacerbating the need to express oneself through social relations and enhance one’s power and prestige (Dittmar & Dury 2000; Kamleitner, Hoetzl & Kirchler, 2012). Over the course of 32 interviews looking into attitudes towards and lay definitions of impulsive and planned buying, Dittmar & Dury (2000) establish that, although consumers may regret the money spent to acquire goods, the psychological and social meaning of those objects plays an important role. Groenland & Nyhus (1994, in Kamleitner, Hoetzl & Kirchler, 2012) provide further support for this, stating that those who were able to make favourable social comparisons in relation to themselves were less presently oriented and discounted future events less, and thus were less prone to use credit.
Research by Palan, Morrow et al., (2011) indicates that compulsive buying is strongly related to credit card usage among a sample of college students in an attempt to define themselves socially through consumption. In effect, credit cards allow them to compulsively borrow money to buttress their sense of self-worth, in line with previous literature which found that self-esteem, power and prestige have been associated with compulsive buying (Norum 2008; O’Guinn & Faber 1989; Roberts and Jones 2000). Impulsive spending and borrowing behaviours are also influenced by perceived lack of control (Livingstone & Lunt, 1992). One way to ameliorate this impulsivity seems to be improved money management plans. As Kamleitner, Hornung & Kirchler (2011) assert, the mitigation of impulsivity seems to rely heavily on efficient and coordinated money management, which leads to a reduction of willpower necessary for controlling spending and borrowing, and subsequently the prevention of indebtedness.
Time preferences are a strong predictor of saving and borrowing behaviours. Although those who are able to delay gratification seem better off when it comes to their spending habits, research has consistently shown these behavioural preferences are deviations from stronger myopic impulses (D’Orlando & Sanfillippo, 2007). Kassam, Gilbert, Boston & Wilson (2008) has shown that, when considering intertemporal choice, people routinely discount future benefits and costs compared to their valuation in the present or near future. Further supporting this, Webley & Nyhus (2008) assert that present rewards are valued more highly than their future counterparts, and future costs are mentally minimized when compared to present costs. Interestingly, Livingstone & Lunt (1992) found that those who owed greater amounts knew the future complications debt would bring, but prioritized the need to attain in the present, rather than saving up for them – however, once they got deeper into indebtedness seem to prioritize the advantages that borrowing brings.
However, complex time preferences play out differently across longer term mortgages. Most orthodox models up until relatively recently assumed that households opt for mortgages to optimize consumption, discounting future events exponentially. In effect, future events are weighed exponentially lightly as time passes (Campbell & Coco, 2003). However, more recent work by Atlas, Johnson & Payne (2017) indicates that these so termed discount rates vary over time. For example, they note that:
“While most respondents prefer, say $60 now over $64 in 4 weeks, many prefer the $64 in 6 weeks over $60 in 2 weeks. Note that the only change in these two choice sets is the addition of 2 weeks to all delays, and suggesting that the immediately available outcome, the $60 now in the first choice is weighted more heavily relative to the $60 in the second”, p.6
In their analysis, they demonstrate that those who are more present-biased and those who are more future discounting (two distinct phenomena) borrowed a larger portion of the cost of their home, were more likely to adjustable interest rate mortgage that was backloaded, and more likely to become ‘underwater’ with their mortgages. However, when the question of whether to walk away from a mortgage arose, present-bias and future discounting worked in separate directions. Since the cost of abandoning a mortgage are borne in the present or near future, present-biased households were more likely to continue paying the mortgage despite negative equity. In contrast, future-discounting households were more likely to walk away from the mortgage, as the value of paying off the debt and owning the home was cognitively minimised. These indicate how time preference can shift and produce different outcomes across time, and entice people to take on bad mortgages that they cannot pay off.
Individuals use a wide variety of money management styles, from the meticulously planned to the recklessly carefree. Livingstone & Lunt (1992) found that flexibility in money management strategies was associated with higher levels of borrowing, whereas those who stringently stuck to their plans fared better. The simplicity of strategies also seems to have some bearing. Put plainly, simplistic plans seem insufficient conserving money in the real world, with Hayhoe (2002, in Kamleitner, Hoetzl & Kirchler (2012)) and Webley & Nyhus (2001) both finding that those higher in debt using simpler money management techniques. Of interest, the formulation and strict execution of money management strategies seems to be associated with high levels of conscientiousness (Donnelly, Iyer & Howell, 2012), one of the five superordinate personality factors within the personality literature (Costa & McCrae, 1985)
Personality, which may be defined as a semi-stable, partially inherited set of patterns of behaviour, cognition and emotion, also has an important bearing on how people borrow and spend money. Early studies in the field conducted by Schmölders (1966; in Nyhus & Webley, 2001) on a representative sample West German households found that conscientious, self-disciplined individuals saved money more frequently and in greater sums, at times roughly double that of more carefree and easy-going individuals. More recently, Brandstätter (1996) and Brandstätter & Güth (2000) corroborate these findings, broadly highlighting three personality factors related to saving behaviour: High levels of Introversion, low levels of Neuroticism, and high levels of Conscientiousness.
However, once more these findings should not be taken as a be-all-end-all of a deeply complex phenomena. Nyhus & Webley (2001) report that in their study high levels of extraversion (measured inversely as introversion above, as part of a bipolar scale), and neuroticism (measured inversely as emotional stability above) were both associated with higher levels of borrowing and lower levels of saving. However, contrary to the both prior findings and the authors’ strongest a priori expectations, conscientiousness did not significantly predict either saving or borrowing behaviour. The authors point out that this may be due to the fact to take part in the panel, households had to be part of Center Saving Survey (CSS) for a minimum of two years. Membership on such a panel would experience differential attrition, according to the authors, which is to say that naturally less conscientious households would peel away, leaving an unrepresentative, conscientiously skewed cohort from which to sample participants. Thus, they point out that differences between households may be one of degree, rather than kind.
Optimism, defined simply as the confident belief about a positive future, seems to have a strong association with borrowing habits. Brown, Garino, Taylor & Wheatley Price (2005) demonstrate that optimism about one’s future financial situation positively affects both quantity and growth of debt at both individual and household levels of analysis. Optimists needn’t be simply confident about future financial situation, but also auxiliary concerns such as healthcare, job security and other life events (Weinstein, 1980) which affect one’s ability to pay debt back by virtue of their potential financial cost. Furthermore, research by Norvilitis et al., (2006) has shown that when indebted, those individuals estimate that it will take less time to pay that debt back than their less optimistic counterparts.
First introduced Julian Rotter in 1966, Locus of Control or LOC simply refers to the prevailing beliefs each individual carries with them regarding whether their lives are controlled from within (an internal locus of control) or from without (external locus of control). An individual’s borrowing habits and numerous other related auxiliary behaviours seem to be discriminated by their LOC. Tokunaga (1993) for example, found that those who were more indebted and unsuccessful in their credit use were more likely have an external locus of control and scored lower in self-efficacy measures, corroborating other studies from the field (Davies & Lea, 1995; O’Guinn & Faber, 1989). These findings aren’t hugely surprising when the association of external locus of control with other psychological factors, such as low self-confidence (Gurol & Atsan, 2006) and self-esteem (Judge & Bono, 2001) and impulsivity (O’Guinn & Faber, 1989).
Support for external LOC and indebtedness is not unanimous, however. Illustrative of this point, Pinto, Mansfield & Parente (2004) found no significant relationship between either self-esteem or more importantly locus of control with credit card spending. However, they do offer an explanation to their findings, stating that they sampled their populations from college students who tend to have above average rates of self-esteem and internal locus of control (Pascarella & Terzini, 1991, in Palan et al., 2011), thereby implying that differences between the conditions groups were differences of degree rather than kind.
On the whole, the literature suggests that individuals are cognitively hamstrung when making decisions about borrowing and the implications, a problem which is compounded when individuals take on multiple loans, each complex and varying in their own right. Kamleitner, Hoetzl et al., (2012) suggests consumers care most about the most immediate and salient aspects of a potential loan, such as monthly repayment amount and loan duration, with total costs and interest rates coming in as secondary concerns. Herrmann & Wrickle (1998) further found that, in a study on German car loans, potential borrowers struggled to understand and integrate the trade-offs between down payments, repayments and overall loan durations. This complexity (Kahn & Baron, 1995) and stress (Leith & Baumeister, 1996) cause people to hone in on a few key salient attributes in an attempt to get a handle on what they face.
Other cognitive quirks include how people seem to linearize, and thereby underestimate functions containing exponential terms, such as those in instalment credit, when assessing them intuitively (Stango & Zinman, 2006; 2009). As such, households displaying more of this Exponential Growth Bias seem to borrow more and save less (Stango & Zinman, 2009).
One consideration to note would be that people do not behave in the same way to different kinds of loan, as different loans are associated with different barriers (say the difference between swiping a credit card as opposed to taking on a home loan). They are thus also associated with different sorts of risks, rewards and pitfalls. As Sullivan, Warren & Westbrook (2000, in Wang, Cheng & Wang, 2008) note, home mortage loans involve much more deliberation and planning, and have a much higher risk of long term inability to pay off large sums of debt. This is contrasted with credit-card debt, which although does contain the possibility of accruing large sums of debt, is a less planned, potentially more impulsive behaviour.
One interesting study which focused specifically on home mortgage loan was that conducted by Wang, Chen & Wang (2008). They found that external locus of control was associated with lower loan ratios, house values and shorter loan terms. Those with external LOC were, by virtue of a heightened sense of pessimism and lack of control, were less likely to consider using a home mortgage loan since they were highly unsure of their ability to pay off such a sum, since they felt less confident in themselves and their abilities to shape the future (Fournier & Jeanrie, 1999). By contrast, those who had internal locus of control were more willing to take larger, calculated risks like home mortgage loans since they were optimistic and confident about their ability to control their lives and by extension their environment, but they were also less likely to impulsively spend using a credit card.
This should serve as an interesting illustration of how a variation on the type of loan interacts with the same psychological structures and attributes to lead to widely different outcomes and behaviours. As such, what is described here should be taken with caution, as a brief but by no means conclusive survey of the current literature relating to borrowing behaviour.
- – Brandstätter & Güth, 1998: A psychological approach to individual differences in intertemporal consumption patterns
- – Brandstätter, 1996, in Donnelly, Iyer & Howell (2012)
- – Brown, Garino, Taylor & Wheatley Price, 2005: Debt and Financial Expectations: An Individual‐ and Household‐Level Analysis
- – Brinig & Buckley, 1998: The Bankruptcy Puzzle
- – Campbell & Coco, 2003: Household Risk Management and Optimal Mortgage Choice
- – D’Orlando & Sanfillippo, 2007: Household Risk Management and Optimal Mortgage Choice
- – Davies & Lea, 1995: Student attitudes to student debt
- – Dittmar & Dury, 2000: Self-image – is it in the bag? A qualitative comparison between “ordinary” and “excessive” consumers
- – Donnelly, Iyer & Howell, 2012: The Big Five personality traits, material values, and financial well-being of self-described money managers
- – Fournier & Jeanrie, 1999: Validation of a Five-Level Locus of Control Scale
- – Green & Wacher, 2005: The American Mortgage in Historical and
- – Hayhoe, 2002, in Kamleitner, Hoetzl & Kirchler (2012)
- – Herrmann & Wrickle, 1998: Evaluating multidimensional prices
- – Atlas, Johnson & Payne 2017: Time Preferences and Mortgage Choice
- – Kahn & Baron, 1995: An Exploratory Study of Choice Rules Favored for High-Stakes Decisions
- – Kamleitner, Hoetzl & Kirscher, 2012: Credit use: psychological perspectives on a multifaceted phenomenon.
- – Kamleitner, Hornung & Kirchler, 2011: Over-indebtedness and the interplay of factual and mental money management: An interview study
- – Kassam, Gilbert, Boston & Wilson, 2008: Future anhedonia and time discounting
- – Lea, Webley & Levine 1993: The economic psychology of consumer debt.
- – Leith & Baumeister, 1996: Why do bad moods increase self-defeating behavior? Emotion, risk taking, and self-regulation.
- – Livingstone & Lunt, 1992: Predicting personal debt and debt repayment: Psychological, social and economic determinants
- – Nofsinger, 2012: Household behavior and boom/bust cycles
- – Norum, 2008: The role of time preference and credit card usage in compulsive buying behaviour
- – Norvilitis, Merwin, Osberg & Kamas, 2006: Personality Factors, Money Attitudes, Financial Knowledge, and Credit‐Card Debt in College Students
- – Nyhus & Webley, 2001: The role of personality in household saving and borrowing behaviour
- – O’Guinn & Faber, 1989: Compulsive Buying: A Phenomenological Exploration
- – Palan, Morrow, Trapp & Blackburn, 2011: Compulsive Buying Behavior in College Students: The Mediating Role of Credit Card Misuse
- – Pascarella & Terzini, 1991: How College Affects Students: Findings and Insights from Twenty Years of Research.
- – Pinto, Mansfield & Parente, 2004: Relationship of credit attitude and debt to self-esteem and locus of control in college-age consumers.
- – Roberts & Jones, 2000: Compulsive buying and risky behavior among adolescents.
- – Rotter, 1966: Generalized expectancies for internal versus external control of reinforcement.
- – Schmölders, 1966, in Nyus & Webley, 2001
- – Stango & Zinman, 2006: Fuzzy Math and Red Ink: Payment/Interest Bias, Intertemporal Choices, and Wealth Accumulation
- – Stango & Zinman, 2009: Exponential Growth Bias and Household Finance
- – Sullivan, Warren & Westbrook, 2000, in Wang, Cheng & Wang (2008)
- – Tokunaga, 1993: The use and abuse of consumer credit: Application of psychological theory and research
- – Wang, Chen & Wang, 2008: Locus of control and home mortgage loan behaviour.
- – Webley & Nyhus, 2001: Life-cycle and dispositional routes into problem debt.
- – Webley & Nyhus, 2008: Inter-temporal choice and self-control: Saving and borrowing.
- – Weinstein, 1980: Unrealistic Optimism About Future Life Events