Out of control: why smart, rich people have credit card debts

THOUSANDS of highly financially literate people in the UK are paying for credit card debt that they could easily pay off with savings, researchers have discovered.

12% of households are incurring interest on an average of £3800 of revolving debt such as credit cards, despite having more than enough liquid assets to immediately pay off what they owe, a paper published this month says.

If these homes paid off the debt they'd still have around one month's disposable income left over in easily accessible cash.

Co-holding behaviour... appears sub optimal but which may actually be welfare improving for consumers.
Gathergood and Weber

The cost of 'co-holding' credit and assets means these households are, on average, spending £650 annually on interest charges that could easily avoid and 20% of co-holders get hit with an unnecessary interest bill of around £1000 every year.

So what drives people to become co-holders? That's the question researchers from the University of Nottingham addressed in their study.

Out of control

Surveying a representative sample of households, the researchers, John Gathergood and Jorg Weber, conclude that co-holding is associated with poor self control and, not as might be expected, with poor financial literacy, lack of education generally or low income.

In fact, their paper 'Self control, financial literacy & the co-holding puzzle' published in the Journal of Economic Behaviour and Organisation, found that co-holders perform better than average at answering questions about financial literacy and have higher levels of education, employment and income than most credit cardholders.

But they are more likely to make impulsive purchases.

The data for the research came from the YouGov Debt Tracker survey, a quarterly survey of approximately 2,500 households forming a representative cross section of UK household finances.

Of the total sample, 350 households hold liquid savings and consumer credit simultaneously while 299, defined as the co-holders, do this with one month's disposable income to spare.

25% of these households were identified as having impulsive spending behaviour, and they were significantly more likely to be co-holders of a minimum £1,000 across consumer credit products.

Co-holders who also report impulsiveness are each estimated to co-hold £3,100 and surrender, on average, £550 in extra interest payments every year.

Smart stupidity

To assess their financial literacy, respondents to this research were asked a series of questions first developed by financial literacy researchers Annamaria Lusardi.

A 'Lusardi' literacy question
Cheryl owes £1000 on her bank overdraft and the interest rate she is charged is 15% per year. If she didn't pay anything off, at this interest rate, how much money would she owe on her overdraft after one year?

As we've seen, co-holders were highly likely to do well on these kind of questions: they understand how credit cards work are unlikely to be paying interest by mistake.

Therefore, researchers say, it's highly likely that co-holders are using the credit limits on their cards as a way to curb their of impulsive spending.

To a co-holder, taking the hit in interest payments is a price worth paying for the discipline a fixed credit limit places on impulsive spending.

While this might sound like borderline stupidity to some, from a co-holder's perspective, its smart.

Having full access to savings would carry a greater risk of letting levels of impulsive spending get out of control.

"In our analysis, co-holding among borrowers better financial literacy is associated with co-holding behaviour which appears sub optimal but which may actually be welfare improving for consumers," the researchers say.

Not so silly? Keeping hold of savings

According to this paper, for co-holders, having some savings and debt is preferable to spending savings and being debt free.

But is it really fair to put this down to them being out of control?

Only one quarter of co-holders said they were impulsive spenders.

Other findings from the survey suggest that people could be co-holding in order to hang on to savings, perhaps to minimise the effect of future income changes. Overall, survey respondents had average savings of £9,211.

In addition, whether co-holding is a temporary or long-term habit is not revealed by this research as the data does not track specific households, which means it is not possible to ascertain if co-holding is a planned behaviour or a short-term financial mistake or strategy.