Borrow Less Tomorrow A behavioral Approach to Debt Reduction

CONVERTING BORROWERS INTO SAVERS: SOME PRODUCT DEVELOPMENT IDEAS FROM THE U.S. HOUSEHOLD FINANCE INITIATIVE

Dean Karlan, Yale University and IPA Jonathan Zinman, Dartmouth College and IPA

May 2011

Problem   

Many households low net worth, financial resiliency High debt loads/reliance in emergencies Highest, safest return for many households: pay down expensive debt  Big

value proposition here: hundreds, even thousands of basis points on the table





But… getting/staying out of debt is difficult, psychologically and cognitively (Value proposition tough sell for consumers?)

Opportunity and Approach 

Product development using behavioral insights to “meet consumers where they’re at”  Product

features that counter behavioral biases  Product features that redirect heuristics, passive learning  Mental

accounting  Habit formation 

Research along with development to refine product design and business model  Market

research  Randomized-control testing

The Skinny on Three Product Ideas 

Pay Back Yourself  Convert



Private Banking for Main Street  Debt



loan payments to savings once loan paid off

and asset consolidation for yield maximization

Borrow Less Tomorrow  Save

More Tomorrow with bigger bang for buck

1. Pay Back Yourself: In Theory  

Problem: hard to get started saving. Solution: seamless conversion of loan payments to savings/investment once loan paid off 



Approach: harness habit formation and mental accounting 



Auto loans, home equity, 1st-mortgages nearing end of term Can reinforce this with messaging 

“You’ve almost paid off your loan, get ready to pay yourself”



“… paid off your car/home, time to save for maintenance”

Other features: upfront commitment, back-end automation

1. Pay Back Yourself: In Practice 

Business Model: cross-sell  Convenience



fee?  Cancellation fee (if don’t honor pre-commitment)?  Other revenue models? Potential distribution channels 

Deposit-taking financial institutions 



with or without loan portfolio

Others?

2. Private Banking for Main Street: Theory 

Problem: habit formation, mental accounting, etc. can be expensive  



Solution: balance sheet level relationship with financial service provider that helps client minimize debt loads 

 

We see debt consolidation in this market. Idea here is portfolio consolidation: linked asset and debt accounts

Automated rules allocate liquidity to optimize debt repayment 



E.g., leave money on table by borrowing high and saving low Or by not borrowing on cheapest credit card

Line of credit backstop

Redirect mental accounting from asset ownership to liquidity ownership

2. Private Banking for Main Street: Practice  

Redfrog Mortgage (BC, Canada) doing a version Business model  Cross-sell

from payment service to line of credit?  Subscription/management fee?  Others? 

Distribution channels  Deposit-taking

financial institutions  Billpay and other payment platforms?  Information/advice engines?

3. Borrow Less Tomorrow: Theory 







Problem: yield-maximizing strategy for many households is to pay down high-interest debt Solution: target this “investment opportunity” with kitchen-sink of behavioral levers Marketing for attention and motivation: Help consumers identify whether they should borrow less Simple Decision Aid: Help making concrete plan to borrow less  



Commitment: Offer creative ways for clients to incentivize themselves o o

o



Accelerate repayment Limit borrowing going forward Social commitment: peer supporters/referees Financial commitment: performance bonds Access commitment: “cut me off if I don’t…”

Ongoing Messaging: Feedback/reminders for follow-thru and maintenance

3. Borrow Less Tomorrow: Practice  

40% take-up rate in high-touch pilot test Revenue model? o o



Subscription (as part of a larger bundle?) Cross-sells (Savings products? Cheaper loan products? Advice?)

Distribution channels Credit bureaus?  Billpay and other payment platforms?  Info/advice engines?  Employers?  Credit counseling agencies (for those who don’t qualify for workouts)?  Debt collectors (post- or even during-collection) 

Summing Up 

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

Huge market opportunity: money on table for helping people save tons of money by borrowing less 

And/or more efficiently



And ultimately save more

Behavioral insights can help develop new products and features to create and meet demand Research discipline can help find business models that work