OPINION5 December 2012

How BE turns debt repayment on its head


Crawford Hollingworth tackles the issue of debt in the run-up to Christmas, and how behavioural economics can be used by financial services firms to help ease the burden on our bank accounts.


UK household debt has risen significantly over the last 10 years. The growth and availability of credit – through credit cards, pay day loans and store cards – have all contributed1. Although consumer credit has fallen a little since the financial crisis, on average2 each UK household still faces a worrying £7,900 in unsecured debt and the Citizens Advice Bureau dealt with around 8,500 new debt cases from individuals in the month of June 2012 alone.

Government advice centres like Directgov and money management advisers like Alvin Hall advocate paying off debts by prioritising those which carry the highest interest rate. Other advice often suggests that you consolidate debt into a single low interest account and then make regular repayments to that.

These strategies may make sense to those who think and behave very rationally and sensibly, but many of us struggle with the huge burden of debt repayment and find the task incredibly daunting. After all, it can take years to clear. If the debt with the highest interest rate is actually your largest sum of money owed, it will be a long time before you have paid it off in full. After a few months of repayments you may feel no closer to the ultimate goal of eliminating all your debts, and simply give up or lose heart.

The snowball effect

Behavioural science has shown recently how a counterintuitive strategy might reap better rewards. Researchers David Gal and Blakeley McShane at the Kellogg School of Management looked at a strategy they dubbed the ‘snowball effect’. Studies of goal attainment show that we need to ‘chunk’ or break up big tasks, inserting sub-goals or interim targets to feel like we are making good progress towards our overall goal, are capable of meeting that goal and are getting closer to our goal. Not only do we need to chunk big tasks, but it is also good to create small wins first. We need success in our initial baby steps and early interim goals to feel like we are making progress.

So Gal and McShane propose that rather than tackle the high interest rate debts first, debtors should tackle and pay off the small debts (whatever the interest). This approach made people more likely to complete all their debt repayments over the course of a few years. Total debt typically ranged from $14,000 to $31,000 spread across four to seven different lenders. They suggest that success in those small, early repayments created a sense of progress and motivation which then led people to feel able to tackle and complete their entire debt repayments3.

Money guru Dave Ramsey4 goes one step further with his strategy. He advises rank ordering your debts by size, and tackling the smallest debt first while continuing to make the minimum repayments on the others. As you gradually pay off each debt, you snowball your repayments by using the money that you were paying towards all the minimum repayments towards paying off the next debt, thereby (like the retirement savings scheme Save More Tomorrow programme5) reducing any feelings of loss aversion since this was money you were not ‘enjoying’ and living off in the first place.

Not only can tackling small debts first help our motivation and sense of progress, but on a more personal level, we may feel morally less pressured or ‘weighed down’.

We are starting to see this thinking coming through in product innovation. The Chase Blueprint card makes use of our need for goal progress6. Unlike most credit cards, it allows you to ‘mentally account’ for different items and break up your repayments into specific items or amounts, for example repaying a big item like a new fridge-freezer with a specific number of repayments. Over time, therefore, you are able to track your progress towards that goal. So rather than just being an unlabelled sum of money for lots of different purchases, the debt now stands for a particular purchase which can help to keep the item salient in our minds and allow us to feel good about ourselves when we finally feel we ‘own our fridge’.

Anchors away

Another interesting finding on debt repayment is how we anchor to the minimum repayments on credit card bills. For people who can’t pay off the whole balance but do try to repay more than the minimum repayment, anchoring effects can make a significant difference to the amount we repay each month. Findings in numerous behavioural economics studies have shown that we use reference points to make our decisions, often without realising it. For example, one well-known study by Ariely, Loewenstein and Prelec found that peoples’ bids for a bottle of wine in a wine auction were anchored to their social security number which they had had to state before the auction – a totally random number7.

In a study which looked at credit card repayments, Professor Neil Stewart of Warwick University found that people who were given no minimum repayment figure paid off more of their debt than people who were shown their bill with this figure, demonstrating how people use the minimum payment as a reference point for any larger repayment they choose to make. Over 400 volunteers were given mock credit card bills for £435.76. For the half that were given a suggested minimum payment, the average repayment made was just £99 on average ( 23% of the balance). The other half – who were not given any required minimum payment – paid an average of £175 – 40% of the balance8. Without a minimum payment to anchor to, people paid more back.

Stewart thinks credit card companies need to illustrate better what different possible repayments will cost customers in the long term – perhaps using a table of repayment scenarios – to make people less susceptible to these anchoring effects. We also tend to anchor to extremes and then pick the middle option(s) so a table which presented three or four repayment options and which included the minimum and a full repayment options could result in higher repayment values.

Crawford Hollingworth is a co-founder of The Behavioural Architects


1. EU Commission: Comparing Key Member States’ Performance, May 2012, http://ec.europa.eu/europe2020/making-it-happen/key-areas/index_en.htm

2. PWC ‘Precious Plastics’ 2012 and Bank of England: Lending to Individuals January 2012

3. Gal, D. and McShane, B.B. “Can small victories help win the war? Evidence from consumer debt management.” Journal of Marketing Research Vol. XLIX, 487-501, August 2012

4. What is the debt snowball? Dave Ramsey https://www.mytotalmoneymakeover.com/index.cfm?event=displayArticle&articleID=118512

5. The Save More Tomorrow programme is a retirement savings scheme devised by Richard Thaler and Shlomo Benartzi which works by reducing any feelings of loss aversion employees might feel as they give up part of their take-home pay into a non-accessible savings plan. Employees on the scheme pre-commit to increasing (or starting) their pension contributions on the advent of their next pay rise, meaning that they do not feel any loss of spending money since they have experienced a pay rise anyway, albeit a slightly smaller one than it would have been.

6. https://www.chase.com/blueprint/

7. Ariely, D., Loewenstein, G., Prelec, D. “Coherent Arbitrariness”: Stable Demand Curves Without Stable Preferences, The Quarterly Journal of Economics, 2003, 118( 1 ): 73-106

8. Stewart, N. “The Cost of Anchoring on Credit Card Minimum Payments” Psychological Science, January 2009 20: 39-41 and http://www2.warwick.ac.uk/newsandevents/pressreleases/research_finds_customers146/