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Does Unsecured Debt Decrease Savings? Evidence from the Refund to Savings Initiative by Michal Grinstein-Weiss, Jane Oliphant, Blair D

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Does Unsecured Debt Decrease Savings? Evidence from the Refund to Savings Initiative by Michal Grinstein-Weiss, Jane Oliphant, Blair D | MARCH 2015 | CSD RESEARCH BRIEF 15-16 | Does unsecured debt decrease savings? Evidence from the Refund to Savings Initiative By Michal Grinstein-Weiss, Jane Oliphant, Blair D. Russell, & Ray Boshara In the wake of the Great Recession, low- and moderate- complete the Household Financial Survey (HFS). They income (LMI) households continue to face significant completed the first wave of the HFS at the time of tax obstacles that prevent them from developing healthy filing and the second wave 6 months later. balance sheets.1 One proposed step toward enabling financial health in these households is to encourage With two waves of survey data from 8,484 LMI saving at tax time,2 when tax refunds bring many LMI households, the 2013 R2S Initiative provides insights households the year’s largest influx of cash. However, into the burden of debt owed by LMI Americans. The high debt may prevent many of these households from average age of survey respondents was approximately saving at tax time. This brief summarizes findings on 35 years, the average adjusted gross income among household debt and saving from the Refund to Savings respondents’ households was $17,520, and the average (R2S) Initiative, which provides detailed information on federal refund was $2,179. Sixty-one percent of HFS the financial lives of LMI households. respondents were female, 64% were single, 43% were college educated, and 20% were non-White. A third of respondents’ households included dependent children. Background Using data from the 2013 R2S, this brief reviews the The R2S Initiative seeks to enhance saving at tax results of an analysis of debt. It also reviews findings time. As described in detail in the 2013 final report,3 on the relationship between financial hardship and R2S is an ongoing collaboration among Washington saving behavior in the financial lives of the 2013 R2S University in St. Louis, Duke University, and Intuit, Inc., sample. This work is motivated by the assumption that the makers of TurboTax. Users of TurboTax Freedom some households may postpone saving in order to pay Edition participated in a randomized controlled trial down debt. Indeed, the growth of household debt has testing the effect of behavioral interventions on savings caught the attention of researchers and policymakers decisions. The experiment was embedded in the tax- in recent years.4 Analyses from the 2013 R2S Household filing software experience. After finishing the TurboTax Financial Survey (HFS) showed that, within 6 months of portion of the initiative, participants were invited to filing their taxes, LMI participants used 43% of their tax » Levels of unsecured debt were high among these LMI tax filers. » Perceived and experienced levels of financial instability were respectively correlated with having both secured and unsecured debt. » Although the LMI tax filer’s level of unsecured debt was negatively associated with the portion of the refund he or she set aside in savings, it was positively correlated with the portion allocated to pay down debt: As the level of unsecured debt rises, the portion saved declines and the portion spent on debt repayment grows. refund to pay down debt and set aside 14% of it for 80% 5 savings. Evidence from an ethnographic study of 69% Earned Income Tax Credit recipients confirms that 70% many expend a sizable share of their refunds to 60% 56% pay down debt but that some also save a portion or make investments (e.g., in education) intended to 50% 6 enhance their chances of upward mobility. 40% 38% 32% 29% 30% 24% 20% Debt Owed by R2S Participants: 15% 14% Secured and Unsecured 10% 7% 7% 6% 1% Two categories of debt are commonly used to 0% characterize household obligations. Secured debt, Car Other Home Medical such as debt owed for a home mortgage or car loan, Property Education Credit card is linked to a specific collateral asset, which the Payday loan Past due bills borrower agrees to surrender if he or she cannot Other bank loan Owe friends/family repay the debt. In contrast, unsecured debt, such Negative balances as debt from a credit card or a payday loan, is not Secured Unsecured linked to specific collateral. Because the price of debt is tied to the risk of lending, the interest or Figure 1. Percentage of HFS respondents who owed debt by type (n = 8,344) fee charged for unsecured debt is generally higher than that charged for secured debt. For example, student loans (56%), medical expenses (38%), the rate of interest on credit-card debt is generally and car loans (32%). Payday-loan debt is often higher than that on a mortgage. the subject of policy debate because of the The HFS asked high average interest participants about rates, but only 7% of three types of secured respondents reported debt: debt from home such debt. loans, car loans, and A substantial proportion (64%) property loans. It posed indicated that they did not know The survey also asked questions about nine participants to report types of unsecured the rate they were charged for interest rates, and a debt: obligations from substantial proportion credit-card balances, their highest-interest-rate debt. On (64%) indicated that student loans, medical they did not know the expenses, past-due average, those who could specify rate they were charged bills, loans by friends for their highest- or family, nonmortgage the highest interest rate reported interest-rate debt. bank loans, payday On average, those loans, negative that it was 24% who could specify the balances on accounts, highest interest rate and other sources. reported that it was 24%. Of the 8,484 HFS respondents, 93% Whereas participants reported that their were more likely to have unsecured than secured households owed some debt. Among those who debt, the average amount of secured debt was reported having debt, just under 3% had only higher. Across the assessed categories of secured secured debt, 42% reported having both types, and debt, the highest average was for debt on property 55% reported having unsecured debt but no secured ($87,211), followed by debt on home mortgages debt. As Figure 1 illustrates, the most common ($80,562) and on vehicles ($9,732). The highest debt, reported by over two-thirds of respondents, average balance for unsecured debts came from was debt from credit cards. Other commonly education loans ($34,185), though respondents reported sources of debt include obligations from reported substantial debt from other loans 2 ($10,738), other types of bank loans ($7,373), 60% 56% credit-card balances ($4,391), and medical bills 7 ($4,281). 50% 40% Debt and Financial Security 33% 30% 29% The most recent data from external sources 30% show that 44% of the U.S. population does not have enough savings to live without income for 20% 3 months.8 The HFS also investigated access to contingency funds, asking respondents about their 10% ability to come up with $2,000 in an emergency: 56% of respondents said that they probably or 0% Secured* Unsecured* certainly could not come up with $2,000 if an emergency arose. Interestingly, respondents’ Holds no debt Debt holder perception of their financial security is associated Figure 3. Respondents who reported having no difficulty in cover- with the type of debt they owed. As Figure 2 ing expenses and bills each month by type of debt (n = 5,316). shows, we found no significant difference between Note: Difference is significant at the 95% confidence level. respondents who did and did not report having secured debt: those with secured debt were not 25% significantly more likely to indicate that they could 23% come up with $2,000 in an emergency. However, 21% we observed significant differences between 20% 19% respondents who did and did not report unsecured debt: those who reported unsecured debt were 15% 14% less confident in their ability to come up with $2,000. These findings suggest that unsecured debt 10% may be a major cause of financial stress for LMI 8% households. 5% We observed a similar pattern in responses to a question about the respondent’s ability to cover all 0% expenses and bills each month: 32% reportedly had No 1st quartile 2nd quartile 3rd quartile 4th quartile unsecured ($1–$4,150) ($4,151– ($15,001– (>$38,301) debt $15,000) $38,300) 80% Distribution of unsecured debt by quartile 70% 67% Figure 4. Respondents who reported difficulty in covering expenses each month by amount of unsecured debt (n = 1,519) 60% 55% 56% 53% 50% 47% 45% 44% no difficulty in covering typical expenses and bills. 40% As Figure 3 shows, however, the ability to cover 33% such obligations varies significantly by whether 30% one owes debt: 33% of those with no secured 20% debt reported that they are able to meet typical monthly expenses, but only 30 of respondents 10% with secured debt reported this. So too, 29% of 0% respondents with unsecured debt reported that Probably or Probably or Probably or Probably or certainly certainly certainly certainly they are able to pay all typical expenses in a could not could could not* could* month, but 56% of those without unsecured debt Secured Unsecured reported the same. Holds no debt Debt holder As Figure 4 shows, the amount of unsecured debt held by participants was also predictive of whether Figure 2. Ability to come up with $2,000 in an emergency, by respondents reported difficulty in covering monthly type of debt (n = 8,329). Note: difference is significant at the 95% confidence level. expenses. Nearly a quarter of those in the highest 3 quartile of unsecured debt said that expenses are 100% very difficult to cover, and 14% of households in 90% the first debt quartile reported the same.
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