Want to improve your credit rating? Perhaps you should work on your tolerance or ability to delay gratification.
A new study finds that people with bad credit scores are more impatient – more likely to choose immediate rewards rather than wait for a larger reward later. In it, two economists attempts to understand the origin of the housing mortgage default crisis.
“Most often, the reasons economists put forward are, maybe there was not enough screening for mortgage applicants, or securitization, or other institutional reasons,” said Dr. Stephan Meier, who was working at the Federal Reserve’s Center for Behavioral Economics and Decisionmaking with Dr. Charles Sprenger at the time they did the research.
“That’s definitely important, but in the end humans make those repayment decisions. So there must be more psychological factors that explain how people make those decisions to default or not.”
The research will be published in an upcoming issue of Psychological Science, a journal of the Association for Psychological Science.
During tax season, Meier and Sprenger recruited 437 low-to-moderate income people at a community center in Boston that was offering tax preparation help.
Each person was given a questionnaire in which they made choices between a smaller, immediate reward and a larger reward later. This is a common test for seeing if people are willing to delay gratification.
The questions offer different time periods and different amounts. The participants also agreed to let the researchers access their credit scores.
Impatient people had lower credit scores. A low credit score can indicate some problems with credit in the past, like failing to pay bills or defaulting on a mortgage.
“Conceptually, it does make sense that how people discount the future, i.e. how impatient they are, affects their decision to default on their loans,” Meier said. “Individuals accumulate debt and then have to decide whether to repay the money or use the money for something else.”
If they don’t pay off their debt, they will have short-term benefits – any cash on hand is available for something else – but the costs/problems come much later, when a landlord, mortgage lender, or someone else sees their bad credit report.
Researchers admit that not everyone defaults on a loan by choice as sometimes people lose their job, experience a significant medical crisis or some other unexpected catastrophic experience.
“But there is a little bit of strategic defaulting going on, where some people make this cost-benefit analysis” – those individuals would rather have more money now and deal with the repercussions later.