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U Research Studies Paradox of Simultaneous Borrowing and Saving

June 2, 2003-Why do people who have savings still borrow money?

According to a recent University of Utah study, a number of factors determine why some people choose to engage in the seemingly contradictory behavior.

The study, conducted by Associate Instructor Heather Spencer and Associate Professor Jessie Fan, both of the Department of Family and Consumer Studies, was based on Spencer’s master’s thesis, which researched borrowing motives and how they might affect behavior. The report was recently published in Financial Counseling and Planning.

For purposes of the study, debts included car payments, credit card and installment debt, home equity loans and other lines of credit, but did not include mortgage payments. Savings included all financial assets, excluding checking account savings, mostly used for daily living expenses and viewed as more transitional. Households were classified into three groups: savers, debtors and simultaneous debtors and savers. Savers had no non-mortgage debt and any amount of savings. Debtors had some non-mortgage debt but no savings besides checking and forced retirement accounts such as 401Ks. Simultaneous debtors and savers (SDS) had both savings and debts.

Simultaneous debtors and savers were influenced by:

— The precautionary motive, or wanting to establish an “emergency fund,” which could be used to build up a reserve against unforeseen contingencies. “Some Americans find it psychologically satisfying to have money in an emergency fund, even if they have concurrent debt,” states Spencer.

— The investment motive. ” Some people think they can invest at 20 percent and borrow at 10 percent so borrowing is worthwhile. Therefore, they are more likely to have simultaneous debts and savings,” says Fan, who specializes in consumer expenditures and financial management.

— The down payment motive, or accumulating money to buy large durables such as cars and houses. “Those with a down payment motive were more likely to be in the simultaneous debtors and spenders group because they would rather borrow money than use money earmarked as the down payment for a house,” explains Fan. “This goes along with the theory of ‘mental accounting,’ or having money mentally divided in our heads. Most people will not use money from their vacation or Christmas account in an emergency,” says Spencer.

— The independence motive, based on the desire to be self-reliant. Researchers thought this motive would decrease the likelihood of borrowing because of the value placed on independence; however, this motive actually increased the likelihood of someone borrowing and saving at the same time. It is possible that households with this saving motive want liquidity to support independence and spontaneity, and therefore use borrowing as a tool to maintain a certain level of liquid assets.

— The bequest saving motive, or wanting to leave one’s fortune to one’s children. “We thought if someone wanted to leave money, they would not want to have debt,” Fan says, “But it turned out these people were more likely to be in the simultaneous debtors and savers group. Perhaps people with this saving motive are only concerned about having more savings than debts. As long as that is the case, there is bequest to be made to their children.” Spencer explains, “One limitation of this study is that the magnitude of savings and debt was not determined. Simultaneous debtors and savers with the bequest motive may have a much higher magnitude of savings than debt; thus, even though they are in the SDS group, after their debts are paid there will still be an inheritance available.”

Rejected was the notion that one might want to save money to start a business while borrowing for current spending, called the enterprise motive. Also rejected was the notion that people would simultaneous save and borrow to enjoy a gradually increasing expenditure or lifestyle.

Respondents studied were taken from the Survey of Consumer Finances, a national study conducted every three years by the Federal Reserve Board, and were a nationally representative sample of non-institutionalized civilian households. There were 1,434 households in the savers group; 2,200 in the simultaneous debtors-savers group; and 388 in the debtors group. According to these statistics, researchers concluded that more than half of the households in the United States are simultaneous debtors and savers. Neither gender nor marital status made a difference in saving and borrowing choices, although researchers found the likelihood of being a simultaneous debtor and saver decreased with age.

One limitation of the study, Fan notes, was researchers did not have information on how much financial knowledge respondents had. “Financial knowledge is a very difficult variable to measure. We thought of using education level as a proxy, but my experience is that someone can have a Ph.D. and not know anything about personal finance,” she says.

“This information is important because it uncovers the possible reasons people may be saving and borrowing at the same time and provides a practical application for financial planners,” Fan explains. “Planners should look at why people borrow, then ask whether it is smart.”