Too Much Debt Leads to Bad Decisions

Aneth Ng-Lim

Posted at Apr 22 2019 08:42 AM | Updated as of Apr 22 2019 08:53 AM

MANILA -- Drowning in debt is never a good thing, but a first of its kind research conducted in Singapore showed owing money not only impacts one’s wallet, but worse, results in a mental burden among borrowers that carries an even higher price than the already steep interest rates they were charged.

The field study involved 196 low-income individuals who owed debts on their house payments, utilities, taxes, phone bills, and were paying installment dues as well. They were awarded a one-time debt relief by Singapore-based charity Methodist Welfare Services as part of its Getting Out of Debt program. Before their debt slate was wiped clean, the average monthly household income of the participants was S$364 (or around P14,000).

To lend some perspective, we can compare this to the P7,337 that a Filipino family of five needs on average to meet the family's monthly basic food needs, as reported earlier this month by the Philippine Statistics Authority (PSA). To cover both food and non-food needs, the amount inches up to P10,481.

Between January 2015 and August 2017, Dr Ong Qiyan and Associate Professor Irene Ng from the National University of Singapore (NUS) Faculty of Arts and Social Sciences, together with Associate Professor Walter Theseira from University of Social Sciences (SUSS) School of Business designed and administered a comprehensive household financial survey that measures anxiety and cognitive functioning as well as financial decision-making of the participants. The survey was conducted before the participants received the debt relief and three months after.

The study was reported by Science Daily in March from the findings published in the journal Proceedings of the National Academy of Sciences.

Ong explained: "One challenge with poverty alleviation policies is the bedrock belief that the poor are indebted because of personal failings. Under this view, those who are trapped in poverty are believed to be lacking in desirable qualities such as motivation and talent that most of the Singapore population possess and value. However, our study shows that because debt impairs psychological functioning and decision-making, it would be extremely challenging for even the motivated and talented to escape poverty. Instead, the poor must either have exceptional qualities or be exceptionally lucky to get out of poverty. It is hard to be poor, harder than we thought."

Theseira added that there are differences in how the poor and the non-poor manage their debts and that the poor needs more assistance.

"Although our study is based on the poor, many non-poor Singaporeans also have debts. Why are some people able to handle debts easily, while others find them stressful and taxing? One difference is that the non-poor have the financial resources to manage their debts conveniently and at low cost. We think nothing of consolidating our bills on a credit card and paying it automatically. We know that we have enough savings to be able to afford an unexpected expense or occasional splurge. So we have a lot of resilience to life's ups and downs that the poor simply do not.”

The study found that the participants experienced less anxiety and improved cognitive functioning, and they could make better financial decisions in just three months after receiving debt relief. Now if we compare among participants, even though they received the same debt pay-out, the one that owed more at the start showed better psychological and cognitive improvements.

These findings confirm that drowning in debt carries quite a mental burden that also results in poor decision-making. The findings also imply that people view each debt as a separate "mental account" and being "in the red" in many debt accounts is psychologically painful.

So with every debt you add to your mental account, you consume more mental resources, experience greater anxiety, resulting in poor cognitive performance. Linking all these, the study disclosed that this potentially prevents the poor from making the right decisions to get out of poverty, further contributing to the poverty trap.

Whether in Singapore or in the Philippines, or in India or China, the sad reality is that the poor are burdened with debt. But helping them financially remains controversial because their debts are often believed to result from bad habits. What the study revealed can turn the tide in the kind of aid that charities extend worldwide to help the poorest of the poor. The focus on extending a hand up (helping the poor make more income) may shift to a combination of hand me down (get them out of poverty first) and then a hand up (keep them out of debt with livelihood opportunities).

Ng pointed out: "The findings in this study opens a pragmatic case for designing good debt relief programs for low-income households. Firstly, they help. In fact, not helping low-income households with debt is counter-productive because not doing so leaves them in suboptimal functioning and high anxiety. Secondly, the design of the intervention is key. As it is the pile up of debt accounts that affects functioning, interventions should focus on decreasing the mental load on low-income households, whose minds are already highly stressed."

The researchers are now examining the longer-term effects of debt relief and are applying the insights from the study to find innovative solutions that may help the poor.

While the study involved a small number of people and only in one part of the globe, it offers an interesting insight into the cost of debt the population of developing countries carries, and the burden they place on the sustainable progress. Here at home, where at least 23.1 million Filipino families fall below the poverty threshold from the latest estimates of PSA, about one-fourth of the national population, that is a sizable burden and a drag that we all need to address.

Disclaimer: The views in this blog are those of the blogger and do not necessarily reflect the views of ABS-CBN Corp.