Payday loans and the psychology of debt.

Payday loans might be costing us more than just money.

In late August, it was announced that Wonga had been placed into administration. The news was not altogether unexpected, with payday loan companies now operating in a much more hostile environment to the one which saw Wonga making a weekly, pre-tax profit of over £1.5m per week in 2012. Ever growing numbers of complaints and compensation claims, coupled with a government crackdown on permissible interest rates ushered in the end of the UK’s largest payday lender.

It is quite easy, though, to give some oversight to the people at the heart of this story. Those in need of ‘quick cash’ to pay their bills, or those more recently coined the ‘working poor’ – those in employment but living from one pay packet to the next. While the collapse of big corporations makes headline news, the human element is sometimes forgotten.

We know that being in debt generally draws negative connotations, which raises two questions – if it is so bad, why is it common, and is it really only detrimental for our finances, or are there other factors at play? What recent research by Walnut Unlimited, the human understanding agency, suggests is that those using these financial services are more likely to report poorer mental health, which needs to be considered as the industry readjusts after the fall of the market leader.

Why we take out loans and the psychology of debt
In its prime, Wonga defined its target market as tech-savvy consumers who had turned away from traditional banks in favour of ‘on-demand’ services. Instead, our recent findings show that those who take out payday loans are in financial difficulty. Those who have had a payday loan are significantly more likely than those who have not to be struggling to make ends meet, and they are also more likely to be working full-time.

Base: Have had a payday loan (193), Have not had a payday loan (1836)

Based on our recent study, the most common reason for taking out a payday loan is to pay household bills (given by 41% of people who have taken out such a loan), closely followed by a crisis purchase such as a broken boiler (39%). Both are indicative of households with little savings to speak of.

Payday loans and difficulties with paying back debts are entwined – the exceptionally high interest rates set by companies such as Wonga, but also their competitors who are poised to take up their market share, make repaying the debt that much harder. So if we can assume that this situation is generally undesirable, why do we do it to ourselves?

Sometimes there is no choice – if your boiler breaks in the middle of winter and payday is a long way off, then borrowing money can sometimes be the only solution, and a payday loan is a quick way to paste over the problem. However, our brains are more complex than this, and we certainly do not always make rational choices. Fear of missing out, peer pressure and our perceptions of those around us are powerful drivers. If all your work colleagues are away on their summer holidays, posting lavish pictures of their meals on Instagram, a short-term loan to fund a weekend break may seem justifiable. Theodore Roosevelt is cited as saying “comparison is the thief of joy”, and it applies here.

Psychologists at Stanford and Vanderbilt Universities have taken this further in Brain, Decision, and Debt, putting forward the idea that ‘anticipatory effect’ can influence our financial decisions. They argue that ‘the promise of immediate monetary gain might elicit increased positive arousal, the promise of delayed monetary loss might not elicit sufficient negative arousal” in our brains. Put simply, our brains may favour ‘quick cash’ in the short term, even if we know that we will have to pay it back plus interest and effectively lose money in the long term.

Debt, credit and wellbeing
Let’s assume then that we can place these people into two rough camps – those who might take out a payday loan because they are struggling to make ends meet, and perhaps to a lesser extent, those seeking the ‘rush’ of an immediate cash fall, or to ‘keep up with the Joneses’. Where there is currently less consideration, however, is the human element behind these groups. It is easy to cluster people based on activity, but less so based on how people feel, which is much less tangible. What our recent research shines a light on is the link between debt and our overall wellbeing. The evidence highlights that those who have had a payday loan, or are struggling with debt, are more likely to be feeling negative about their lives generally. Financial instability, and the stresses which come with it, also appear to be linked to poorer mental health specifically, with those who have had a payday loan or are struggling with debt more likely to report negative feeling about their mental wellbeing.

Feelings about life in general

Q1 On a scale from 1 to 7, where 1 is ‘Extremely negative’ and 7 is ‘Extremely positive’, how would you say you currently feel about your life in general?
Base: Have had a payday loan (193), Have not had a payday loan (1836)
Struggling to pay back debts (308), Not struggling to pay back debts (1682)

Feelings about mental health

Q3 Using the same scale as before, please indicate how you feel about each of the following aspects – Your current mental health
Base: Struggling to pay back debts (308), Not struggling to pay back debts (1682)
Have had a payday loan (193), Have not had a payday loan (1836)

Additionally, it seems that this effect is more pronounced with a payday loan than other common types of loan. Those who have ever had a payday loan are the most negative group regarding their mental health, and it may be the case that poorer mental health leads to decisions that make people financially vulnerable. At its core though, it seems apparent that payday loans and poorer mental health are linked.

Q3 Using the same scale as before, please indicate how you feel about each of the following aspects – Your current mental health
Sample bases in parentheses

What’s next?
For some, payday loans are a welcome quick fix in times of crisis or desire. But if we scratch the surface, we can see that debt is related to poorer wellbeing and specifically mental health. As the industry realigns after Wonga’s demise and considers its offering to customers, it would do well to bring this element of human understanding into the mix.