Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

INTRODUCTION

The history of credit dates back to the emergence of mankind. When a person requires something materialistic, then he usually follows two available courses of actions, one is ethical and the other is unethical. Unethical ways of procuring things deals with adoption of unfair methods like deceit, stealing, procuring through coercion, shop lifting or robbery, to name a few. Such methods being illegal in the eyes of law, are not been pondered in this study. The ethical ways of fulfilling requirements includes barter system[1] andacquiring or borrowing. Acquiring or borrowing includes monetary transactions between buyer and seller or between borrower and lender respectively. This nature of human beings getting indebted to the lender for fulfillment of their requirement is not new to the society and so is the case with associated defaults and its consequences thereof. During the epoch of past few decades, many options of credit had developed in the society and also, with the advent of retail banking, debt has taken different facets in the modern era.

Today, even the government is encouraging people to take loans for certain purposes. A tax concession on housing loans is one of the indicators of this fact. This is so because even the government recognizes that credit extension is an integral link in the transmission mechanism that relays changes in monetary policy to changes in the total demand for goods and services and rate of inflation. Enhanced lending on several fronts contributes a lot in the economic development of the country. GDP growth rate was at 4.30% in year 2003, rose to 8.3% in 2004 and was recorded at 6.2% in 2005, 8.4% in 2006, 9.2% in 2007, 9% in 2008, 7.4% in 2009, 7.4% in 2010, 8.2% in 2011, 8%, 6.7%, 6.1% and 5.3% for the Quarters 1,2,3 and 4 respectively for the year 2012-13 and the 5.5% for the first quarter of 2013. Among several significant reasons for boom in Indian economy, easy availability of loans and the reasonable rate of interests at which these loans are available are also cited as important contributors. These days, banks are giving loans for and loan against any and everything.

Often there are individuals/ households who at times fail to meet the payment deadlines on their debts and therefore have to bear the brunt of penalties imposed on themby their respective lenders. This brings in light the importance of taking rational decisions regardingexercising the option of seeking credit, amount of credit, source of credit and the maximum period for which the funds are to be borrowed. In addition, it also highlights the significance of prudently managing debts, once the option of getting indebted is exercised.

In the era of rising demands of individuals, it has almost become a fashion to finance the requirements. Nonetheless, a detriment faced by individuals in enjoying the benefits of financing the personal requirements is cost which happens to be in the nature of interest obligation required to be paid to the lender. There are different reasons to accept the choice of becoming indebted. A loan may be borrowed to buy a home, buy a car, pay the fee for higher education, payoff previous loan/s or may be to finance a wedding and so on. Credit cards today also play a major role in making people indebted to banks. The culture of credit cards has grown at such a fast pace that people have in fact now become habitual of carrying and using credit cards for their purchases or bill payments.

The two major components of household debt are customarily classified into household credit and mortgage advances. Household credit or consumer credit is, in turn, may broadly be classified into Vehicle Loan (including auto loan and car loan), Education Loan and Personal Loan. Mortgage advances is used to refer to home loans.

LITERATURE REVIEW

Sharma Zeller (1997)[2] argued that “females are less likely to default because they choose less risky projects.”

Prinsloo (2002)[3] has defined debt (including household debt) as “an obligation or liability arising from borrowing money or taking goods or services ‘on credit’, i.e. against an obligation to pay later.”

Getter (2003)[4], “consumer delinquency problems are mainly the result of unexpected negative events that neither the lender nor the borrower could have anticipated at the time the credit request was evaluated. The size of the household payments burden has an insignificant effect on delinquency risk and very little effect on default risk. Household financial assets that can be used as a buffer against negative shocks also serve as a very important predictor of delinquency risk.

Debt delinquency refers to late debt payment behavior, which would immediately result in lower credit scores, jeopardize opportunities to receive future consumer credit, and adversely affect consumer financial well being (Getter, 2006; Lyons, 2003)[5][6].

Mc Kenzie, Liersch Finkelstein (2006)[7] have suggested that defaults may be chosen for three reasons. The first is effort: choosing the default option requires no physical action and can free one from laborious calculation. The second is implied endorsement: decision-makers may infer a default has been pre-selected due to its merit or the desire of those presenting the choice. Finally, defaults may result from reference dependence: the default option may represent a reference point from which colors the evaluation of other options as gains or losses.

Duyhan-Bump and Charles (2009)[8] argued that households in countries with an institutional environment which is more efficient in the collection of overdue debts are less likely to fall into arrears.

Amar, Dan, Shahar, Cynthia & Scott (2011)[9] from their experiments revealed evidence of debt account aversion. They identified that the participants consistently paid off small debts first, even though the larger debts had higher interest rates. They also found that restricting participant’s ability to completely pay off small debts, and focusing their attention on the amount of interest each debt has accumulated, helped them reduce overall debt more quickly.

Bandyopadhyay & Saha (2011)[10] suggested that the borrower defaults on housing loan payments is mainly driven by change in the market value of the property vis-à-vis the loan amount and EMI to income ratio. They also identified that default on home loans also gets triggered depending upon the borrower characteristics like marital status, employment situation, regional locations, city locations, age profile and house preference.

Married couples with children and single females with children are more likely to be late in debt payments. Household head’s age shows an inverse U-shape on the risk of debt default (McCloud & Dwyer, 2011)[11].

David, Nyakundi Wesonga (2012)[12] in their study reached to a conclusion that “gender, size of the borrower’s family, loan purpose, amount of credit obtained, loan processing and disbursement time, interest rate charged, profit anticipated from produce sales, loan diversion, amount of loan diverted, number of visits by loan officers, borrower’s market place, income from relatives and friends, age and education level influence loan repayment behavior.”

Stefano Franceso (2012)[13] studied the influence of attitude on consumer credit decisions. He identified that the influence of attitude on consumer credit decisions cannot be ruled out. Attitude toward credit appears to play an important role and is significantly related to motivations for using credit and to the method of choice for financing consumption.

“Younger consumers are found to be borrowing more heavily and repaying at lower rates than older generations. The accumulation of credit card debt is found to continue over the lifecycle. This has implications for recent changes in laws governing the credit card industry. Increases in minimum required payment rates are examined and are found to increase actual payoff rates more than proportionately.(Sarah & Lucia, 2013)[14]

According to the study made by Jack, Ralph Richard (2013)[15], “people underestimate the amount of time it takes to eliminate a debt when payments barely cover interest owed, and this effect was worse for those low in numerical skill. Less numerate individuals tend to underestimate the monthly payment required to pay off a debt in three years, whereas those more numerate tend to overestimate.”

SIGNIFICANCE OR PROPOSED OUTCOMES OF THE RESEARCH

The purpose of the study is to enable individuals with knowledge that can act like a guideline for them in effectively and efficiently managing their debt obligations. With the use of the study, it would become easy for individuals to estimate the maximum amount they can borrow and the actual cost at which it would be comfortable for them to honour their debts.

The study will not only prove fruitful for individuals as borrowers or prospective borrowers but will equally be helpful to the financial institutions. The study will disclose vital information to the lenders about borrowers, their set of requirements, their viewpoints on the lending policies, problems encountered by them in meeting their obligations, i.e., the reasons for defaults, etc. Accordingly, the study will guide lenders in formulating a strategy to handle the backdrops of lending in any of the category of loans.

Grant of credit by lenders and its efficient usage by individuals in constructing their assets suggests wealth formation in the country which signals towards economic development. Though indirectly, but the study will again prove to be constructive in the process of economic development.

It is expected that individuals exercising an option to be indebted is positively correlated to future planning and status

OBJECTIVES OF STUDY

The main objectives of the present study are:

1)To analyzethe various factors due to which individuals choose to be indebted.

2)To analyze the various reasonsdue to which borrowers default in repaying their debt.

3)To studywhether there existany difference between the estimated cost of borrowing and the actual cost paid by the borrowers.

4)To construct a model for borrowers that may help them in judging their repaying capacity.

PROPOSED RESEARCH METHODOLOGY

In order to fulfill the above mentioned objectives, the study intends to adopt the following research methodology:

Data Source

To make present study more scientific it has been planned to use both types of information i.e. primary as well as secondary data sources. For secondary dataefforts would be made to use all the published information from Research Journals, books, journals, magazines, newspapers and periodicals of government and reports of RBI.For this purpose various libraries in the country will be visited to collect relevant information. For the collection of primary information, the researcher would like to construct and administer a questionnaire from the customers and official executives of selected banks.

To analyze the Primary and secondary information, 6 commercial banks will be selected on the basis of maximum number of branches in India.An equal proportion between public and private sector banks will be taken for the study. Survey with the help of self constructed tool (Questionnaire) will be carried out from 300 individuals who must have borrowed loan/s from banks for non-commercial purposes during the years 2006 to 2011. Out of 300 respondents, there will be an equal distribution of respondents for home loan, vehicle loan, education loan, personal loan and credit card. Selection of individuals would be based on random sampling.

Primary Data collection tools

  • Questionnaire
  • Interview

Statistical Analysis

The present study intends to make use of tabulation, percentages, averages, standard deviations and correlations. Chi-Square test will be used to examine the various null hypotheses framed during the course of study.

HYPOTHESIS

The present study can be categorized as an exploratory research carried out with the help of opinion survey along with the use of published information. To provide the scientific base to the findings, researcher has constructed the following Null Hypothesis (Ho):

1)Null Hypothesis – An option to be indebted by individuals is not correlated to future planning and status.

Alternate Hypothesis – An option to be indebted by individuals is positively correlated to future planning and status.

2)Null Hypothesis – The actual cost of borrowing is equal to the cost declared by the banking authorities.

Alternate Hypothesis – The actual cost of borrowing is not equal to the cost declared by the banking authorities.

In addition to above stated hypothesis the researcher may construct a few other hypotheses during the course of the study.

PROPOSED PLAN OF THE STUDY: -

Chapter 1 – Introduction

Chapter 2 – Review of Literature

Chapter 3 – Research Methodology

Chapter 4 – Comparative Analysis of Public vs. Private Sector Banks

Chapter 5 – Analysis and Interpretation of Data

Chapter 6 – Model Structure and Model Development

Chapter 7 – Conclusion and Suggestion

Bibliography and References

Appendices

REFERENCES

  1. Amar, M., Dan, A., Shahar, A., Cynthia, E. C., & Scott, R. (2011). Winning the Battle but Losing the War: The Psychology of Debt Management. Journal of Marketing Research, 48, 38-50.
  2. Bandyopadhyay, A., & Saha, A. (2011). Distinctive Demand and Risk Characteristics of Residential Housing Loan Market in India. Journal of Economic Studies, 38 (6), 703-724.
  3. David, M., Nyakundi, E., & Wesonga, J. (2012). Factors Influencing Loan Repayment in Savings and Cooperative Societies. A Journal of the Management University of Africa , 244-258.
  4. Duyhan-Bump, B., & Charles, G. (2009). Household Debt Repayment Behaviour: What Role do Institutions Play? Economic Policy, 24 (57), 107-140.
  5. Getter, D. (2003). Contributing to the Delinquency of Borrowers. Journal of Consumer Affairs, 37 (1), 86-100.
  6. Getter, D. E. (2006). Consumer Credit Risk and Pricing. Journal of Consumer Affairs, 40 (1), 41-63.
  7. Jack, S. B., Ralph, K. L., & Richard, L. P. (2013). Consumer Misunderstanding of Credit Card Use, Payments, and Debt: Causes and Solutions. Journal of Public Policy and Marketing, 32 (1), 66-81.
  8. Lyons, A. (2003). How Credit Access has Changed Over Time for US Households. Journal of Consumer Affairs, 37 (2), 231-255.
  9. Mc Kenzie, C., Liersch, M., & Finkelstein, S. (2006). Recommendations Implicit in Policy Defaults. Psychology Science, 17, 414-420.
  10. McCloud, L., & Dwyer, R. E. (2011). The Fragile American: Hardship and Financial Troubles in the 21st Century. Sociological Quarterly, 52, 13-35.
  11. Prinsloo, J. W. (2002). Household Debt, Wealth and Saving. Quarterly Bulletin.
  12. Sarah, J. S., & Lucia, D. F. (2013). New Evidence on Credit Card Borrowing and Repayment Patterns. Economic Enquiry, 51 (1), 394-407.
  13. Sharma, M., & Zeller, M. (1997). Repayment Performance in Group Based Credit Programs in Bangladesh: An Empirical Analysis. World Development, 25 (10), 1731-1742.
  14. Stefano, C., & Franceso, P. (2012). Psychological Determinants of Consumer Credit: The Role of Attitudes. Review of Behavioural Finance, 4 (2), 113-129.

WEBSITES

  1. bankbazaar.com. (2010, April 27). Bank Loans Including Personal Loans Increase by 17% as on April 9. Retrieved October 2012, from
  2. Retrieved December 4, 2010, from &Mode=0
  3. Retrieved December 4, 2010, from
  4. Retrieved June 27, 2013, from

Ruchi Bhatia1Dr. Jayender Verma

(Research Scholar) (Supervisor)

[1] It is one of the oldest methods of exchange mainly followed before the evolution of money. In this system, people exchanged goods or services for other goods or services without using a medium of exchange, for example – an exchange of a loaf of bread for some jam.

[2]Sharma, M., & Zeller, M. (1997). Repayment Performance in Group Based Credit Programs in Bangladesh: An Empirical Analysis. World Development, 25 (10), 1731-1742.

[3]Prinsloo, J. W. (2002). Household Debt, Wealth and Saving. Quarterly Bulletin.

[4]Getter, D. (2003). Contributing to the Delinquency of Borrowers. Journal of Consumer Affairs, 37 (1), 86-100.

[5]Getter, D. E. (2006). Consumer Credit Risk and Pricing. Journal of Consumer Affairs, 40 (1), 41-63.

[6]Lyons, A. (2003). How Credit Access has Changed Over Time for US Households. Journal of Consumer Affairs, 37 (2), 231-255.

[7]Mc Kenzie, C., Liersch, M., & Finkelstein, S. (2006). Recommendations Implicit in Policy Defaults. Psychology Science, 17, 414-420.

[8]Duyhan-Bump, B., & Charles, G. (2009). Household Debt Repayment Behaviour: What Role do Institutions Play? Economic Policy, 24 (57), 107-140.

[9]Amar, M., Dan, A., Shahar, A., Cynthia, E. C., & Scott, R. (2011). Winning the Battle but Losing the War: The Psychology of Debt Management. Journal of Marketing Research, 48, 38-50.

[10]Bandyopadhyay, A., & Saha, A. (2011). Distinctive Demand and Risk Characteristics of Residential Housing Loan Market in India. Journal of Economic Studies, 38 (6), 703-724.

[11]McCloud, L., & Dwyer, R. E. (2011). The Fragile American: Hardship and Financial Troubles in the 21st Century. Sociological Quarterly, 52, 13-35.

[12]David, M., Nyakundi, E., & Wesonga, J. (2012). Factors Influencing Loan Repayment in Savings and Cooperative Societies. A Journal of the Management University of Africa , 244-258.

[13]Stefano, C., & Franceso, P. (2012). Psychological Determinants of Consumer Credit: The Role of Attitudes. Review of Behavioural Finance, 4 (2), 113-129.

[14]Sarah, J. S., & Lucia, D. F. (2013). New Evidence on Credit Card Borrowing and Repayment Patterns. Economic Enquiry, 51 (1), 394-407.

[15]Jack, S. B., Ralph, K. L., & Richard, L. P. (2013). Consumer Misunderstanding of Credit Card Use, Payments, and Debt: Causes and Solutions. Journal of Public Policy and Marketing, 32 (1), 66-81.