Decreasing pain of payment to save while paying off debt

Background

Many individuals view paying off debt, saving, and building assets as consecutive steps towards financial wellbeing. In reality, though, individuals rarely have the luxury of tackling their financial goals one at a time. A 2020 report by LendingTree found that Americans hold a total of $1.2 trillion in auto loan debt, paying an average of $550 per month on new car loans. With auto loan terms stretching an average of 69 months for new car loans, and auto loan debt comprising just 10% of the total national household debt, waiting to save until one is completely debt free could mean waiting a very long time. And for the 37% of households who report being unable to cover a $400 financial shock with cash or its equivalent, often all it takes is one unexpected expense or emergency to fall off track and deeper into debt.

Having a cushion of savings makes it more likely for someone to successfully pay off debt and to build assets and savings, but saving while paying off debt is challenging. We partnered with Guadalupe Credit Union (GCU), a credit union serving low-income members in Santa Fe, New Mexico, to help members who take out a loan to open and save by contributing to a Pay Yourself First CD (PYFCD) while paying off their loan. The PYFCD is unique to other savings accounts in that it matches the interest rate of the member’s loan, meaning their savings will grow at the same percentage as their loan. Contributions to this CD cap at a maximum of 10% of each loan transfer, including both the loan principal and interest.

Key Insights

To collect information specific to this context at Guadalupe Credit Union, we conducted a behavioral diagnosis of their PYFCD product. This diagnosis included building a detailed process map by analyzing administrative data and conducting qualitative interviews with frontline staff. The following barriers emerged as especially relevant:

• Members view a savings contribution equally as painful as a loan payment. Every time an individual parts with hard-earned money, even if this money is for their future selves, it inflicts psychological pain. Members who are asked to sign up for another recurring payment into their savings immediately after discussing the recurring payment for their new loan feel a second instance of psychological pain.

• Members commonly budget in round numbers and lean towards them in both general use and under times of cognitive overload.

• Members do not consider the benefits of opening a PYFCD in the moment of decision making. There is a general tendency to be present biased and have disproportionately higher valuations of present benefits and extremely low valuations of future benefits.

Experiment

We hypothesized that presenting the PYFCD as a default part of a members’ loan, rather than as an extra add-on, would increase the likelihood of enrollment and contribution to the PYFCD. By rounding up the payments to a round number, we hypothesized we could both decrease the psychological pain of payment and align with members’ existing mental budgeting strategies, since they have likely already mentally rounded up their loan payment. However, we were also curious about whether it was important that the higher number was round, like $250.00, or not, like $249.97 or $251.56.

To test our hypotheses, we redesigned GCU’s loan payment form to offer the PYFCD bundled together with each loan. Rather than view and approve two separate payments, members were presented with one monthly payment amount and shown how the amount included payments both to their loan and to their PYFCD, should they choose to open it. We also triggered loss aversion by showing members the amount they were likely to have saved at the end of their loan if they signed up for the PYFCD.

To help loan officers remember to offer the PYFCD, we integrated the new payment calculations into the debt ratio calculator that GCU team members already use and held training sessions on how to introduce the program to members. When members applied for a new loan, they were randomly assigned to see one of three different forms, where the only thing that varied was the round-up amount. The conditions were balanced such that on average, members would save about the same amount regardless of whether their payment was round or specific.

Specific 9.4% condition: Loan + PYFCD payments are presented as a specific number (9.4% of the member’s loan principal and interest is calculated).

Specific 10% condition: Loan + PYFCD payments are presented as a specific number (the maximum 10% of the member’s loan principal and interest is calculated).

Round condition: Loan + PYFCD payments are presented as 10% of the member’s loan principal and interest rounded down to the nearest $5.00.

Results

We ran our intervention for 12 months, collecting data from 1610 new loans at GCU branches. When we began our experiment, there were 356 open PYFCDs throughout the history of the product. In the 12 months that we ran our intervention, members opened 690 new PYFCDs, nearly doubling the previous total number of PYFCDs. When our redesigned forms were used, 42% of members opted to open a PYFCD and save off of their loan. These 690 members will save an average of $1,872 each by the end of their loan. Overall, these members will have a combined total of $1,829,967 in savings by the end of their loans.

We found no significant difference between our conditions. Around 42% of members chose to open a PYFCD regardless of whether their payment was presented as a round or specific number. This might be because the details of the transfer amount do not seem salient for the member at the time of signing the loan. They may not be thinking of how the payments will fit into their monthly budgets as they make the decision about whether to open a PYFCD.

At the time of our analysis, 78% of the members who chose to open a PYFCD had an active CD account. Six percent of members had matured CDs, taking home an average of $1,566 per account. Only 15% of members had chosen to close their CD prematurely.

We found that as loans got bigger, members were statistically significantly less likely to open a PYFCD. Similarly, the projected amount saved and acceptance rate were significantly negatively correlated: as the amount to be saved grew larger, people were less likely to open a PYFCD. This could be because members taking out larger loans may have less money to spare for the PYFCD. It may also seem intimidating to lock a larger amount of money away until the end of a loan. It’s possible that savings mechanisms that bundle together savings with payments might be best suited for smaller dollar loans. Similarly, credit score was a significant predictor of PYFCD status, with participants with lower credit scores tending to close their CDs earlier and more frequently than participants with higher credit scores (p<0.04***, α = 0.05). It may be that bundling loan payments with a CD is a savings mechanism that works best for those with higher credit scores, who may be better able to participate in less liquid forms of savings such as putting money into a CD and waiting for it to mature.

While we failed to see any evidence that rounding up a loan payment affects uptake of this savings product, this experiment did demonstrate the importance of creating smart defaults and embedding savings into existing processes. Thanks to thoughtfully crafted defaults, Guadalupe Credit Union’s new automobile loans are encouraging nearly half of new borrowers to begin a savings habit and start to build their financial cushions. At scale, Guadalupe Credit Union can expect to help nearly 700 members a year stow away almost $2,000 in savings each by the end of their loan terms.