Do You Understand The Psychology Of Debt?

The emotional impact of debt can be crippling.  For many people, being in debt drains their energy and enthusiasm for life.  Our collective personal indebtedness is higher now than ever before.  But why do people get into debt?  And when in debt, why is it so difficult to get out of?

In this post I’ll explore the seduction of debt and why it has a hold over so many of us.  In my next post I’ll talk about the psychology of indebtedness, and how to beat it.

There are two psychological processes at work which encourages us into debt.

1.       Future Discounting.

This is a general psychological principle which applies to many things including debt.  For example we are all familiar with the idea that we can plan a day and find that we underestimated the time it would take to do everything.  This is an example of what I call ‘future discounting’.  In this case we predict how much work we can do in a day and discount, i.e. underestimate, our ability to do it.

The same applies with debt.  We often take on debt and we don’t really work out in detail how we are going to deal with it.  We look to the future and discount the pain of making the repayments.  If we can’t even get tomorrows schedule right, just imagine how dangerous taking on debt can be when you are ‘future discounting’, sometimes years ahead!

Of course the companies that supply credit know this principle very well.  In fact they sell to us on the basis of future discounting, and we see it in deals that supply credit cheaply for six months, then the interest rate rises steeply.  We future discount our ability to clear the debt before the interest rate rises.  It is on the basis of the steep interest rate that these companies make their money, and they know we will fall into the trap, that’s why they set it up for us in the way that they do.

The worst culprits are the ‘buy now, don’t pay anything for a year, then pay over three years’ deals.  Psychologically it ‘feels’ like it’s something for nothing … but it very much is not.  These deals often supply the lowest quality goods’ at the highest interest rates, and tie you up in debt with nothing good to show for it.

1.       Consumption and Personal Identity.

A famous Philosopher, Rene Descartes one wrote “I think therefore I am”.  This might have been true for an academic in the 17th century.  In the 21^st century, it might be better to say “I consume therefore I am”.  Never have we be so brand conscious.  Kids especially are vulnerable to this.  Perhaps because they feel their ‘needs’ so acutely, and haven’t yet learnt to keep them in check, they put enormous pressure on their parent to buy the latest gadgets and clothing.

As adults we don’t escape these pressures.  We identify with brands because we want to be a part of something bigger.  Consumption of a brand is something that, in a small way, allows us to feel connected and engaged with this bigger narrative.  Of course the narratives are powerful, they promise youth, beauty, health and endless sexual triumphs.  Who doesn’t want to live the Victoria and David Beckham lifestyle?

Allowing our self esteem to be contingent on such purchases is precarious.  In order to feel good about ourselves we need to keep buying the product.  Of course manufacturers know this, that’s why nothing is made to last these days.  From light bulbs, computer operating systems and cloths, to perfumes, furniture and even cars, everything is designed to fail, fall apart and degenerate, fuelling another wave of consumption to make us feel good about ourselves.  A more secure basis for self esteem is through our relationships to other people:  being a good father, husband, boyfriend or mate.  You can’t buy these things, but being them will make you much happier than purchasing a pair of Armani Jeans on you Barclaycard.

On their own, each of these psychological processes are dangerous, put them together, and they are toxic.  What results is people who buy on credit the lifestyle they feel they deserve but can’t afford to pay back until a later.  We all know this is nonsense, but we do it all the time.  When payback time comes, we find we can no longer afford the lifestyle we need to feel good about ourselves, and this fuels further purchases on credit.

The psychology of saving is for another post, but the benefits are obvious; by not paying interest, you can actually afford to buy more!