As part of Nest Insight’s work on financial resilience, supported by JPMorganChase, we’re exploring the potential of joining up borrowing and saving in ways that could support households to build financial resilience.
In the third part of our research preview, we expand on why we are prioritising this innovation space for further research and development, and introduce the evaluation and trials we will be doing over the coming year.
An ‘irrational’ phenomenon?
Many economists view co-holding savings and debt as irrational. Consumer finance experts advise paying off loans before saving in almost all circumstances. For example, Martin Lewis explains:
“£1,000 debt on a credit card at 23% costs £230 in interest over a year.
£1,000 saved in a savings account at 5% earns £50 in interest over a year.
So pay off the debt with the savings and you’re £180 a year better off. It’s that simple. Debts usually cost more than savings earn. Cancel them out and you’re better off.”[1]
This is clearly sound advice for maximising your money.
But around three in ten (27%) households in the bottom half of incomes in the UK who are in debt also have some savings. And that rises to four in ten (40%) of households in the top half of incomes.[2] So why do so many people keep savings back rather than paying off as much debt as possible?
Preserving a savings cushion alongside a loan gives control and peace of mind
A research study by the US Consumer Financial Protection Bureau [3] explored the psychology behind this behaviour. Participants were given a scenario of a person with $5,000 in credit card debt, and were randomised into groups in which this person also had varying levels of savings, from $1,000 to $10,000. They then had to decide how much of the debt the person should pay off with their savings. Overall, most participants chose to pay off some of the credit card debt, but also to preserve some savings. This was true even when the initial savings amounts were high enough to allow them to completely pay off the debt and still retain a savings balance of thousands of dollars. This finding suggests that participants were willing to retain some debt in order to maintain a savings cushion.
So, did the study participants lack financial capability? Would they have paid off more of the credit card bill if they had only understood that the cost of the debt was higher than the return on the savings? Here’s the important part: ‘Most participants in the study (79%) accurately reported that the typical interest rate for a credit card exceeds that of a savings account. This suggests that participants were equipped with appropriate knowledge to understand the interest rate trade-off between credit card debt and savings.’ The researchers expected that people who correctly answered the interest rate questions would be more likely to use more savings to pay off the debt than those who didn’t. But they did not see this.
This finding did not surprise us at Nest Insight. We hear time and again that people want to have a savings buffer because it gives them greater peace of mind and control over their lives. Knowing that there’s a bit of money put aside to cope with an unexpected expense, or a period of lower income, reduces anxiety and allows people to feel more independent and empowered.
This is perhaps particularly likely to be true for individuals with volatile incomes, for those who worry they might not be able to borrow money when they need to because of a low credit rating or thin credit file, and for those who are mistrustful of formal financial solutions and providers.
So, in many cases, the ‘co-holding’ behaviour does not seem so ‘irrational’ if we take into account the full context of people’s lived experience and the trade-offs they are making. They are simply valuing the benefits of the control and peace of mind that savings give above their financial cost in additional interest paid.
There’s therefore an opportunity for more joined-up, behaviourally designed approaches that could better work with existing behaviours and preferences, bringing together borrowing and saving. Instead of lending and saving sitting in silos, they could be connected in ways that help people sequence and prioritise their financial needs, thinking about consumer value holistically.
‘Save-as-you-borrow’ models already exist and are well-regarded
The credit union sector has understood this need for decades and has established solutions where members are supported to save alongside borrowing. Many credit unions’ model for lending is to include a savings contribution as part of a loan repayment as the default, automatically opening a savings account for the member when they take out the loan (or continuing some saving alongside the loan where they were already saving with the credit union). Previous research suggests that this approach supports people to become savers who might not otherwise have got started with saving, that it helps people save regularly over time and that saver-borrowers gain confidence from knowing that they are saving even as they pay off their loan.[4]
We recently heard from one of our research participants how taking out a credit union loan that was available in her workplace had helped her build savings which she would not otherwise have had, which then helped her to pay for funeral costs:
“This way worked for me…You can see it mounting up. You’re still paying off what you owe but eventually you get that back – I did find that quite helpful. Anything you can save even the odd £5 here and there works for me. That really did save my day, because I took out the full £500…and it helped with the funeral costs and stuff like that when we needed it. That’s a big thumbs up for me. If I had to do it with a direct debit and I had to physically pay it each month it wouldn’t get done.”
Different credit unions offer different versions of ‘save-as-you-borrow’ – sometimes savings are locked up until the loan is paid off, sometimes they are fully accessible throughout. Sometimes the saving amount is fixed at £5 or £10 a month, sometimes it is set relative to the loan repayment amount. Some credit unions require people to save before they will offer a loan, or offer better loan rates to members with savings.
We’re keen to better understand the experiences borrowers have of these different models and to robustly evaluate their effectiveness. To do this we’re excited to be currently working on an evaluation with a group of , in partnership with the Financial Inclusion Centre and the Personal Finance Research Centre from the University of Bristol. Participating credit unions currently include: Cardiff & Vale Credit Union, Serve and Protect Credit Union; Commsave; Manchester Credit Union; Transave; Great Western Credit Union; The Money Co-op.
There’s an opportunity to support saving across the loan journey
Although saving alongside borrowing from the start of a loan may be right for some people, we’re also exploring whether there are other opportunities to support borrowers towards financial resilience at different points in their borrowing journey.
One potentially salient touchpoint is the moment at which someone pays off their loan. If they are used to spending a certain amount a month on paying off their debt, could this transition to become a regular saving amount before they ‘feel’ the money in their pocket again? And could pre-committing to this transition from the start of the loan overcome some of the barriers to saving like the need to set up a savings account and mechanism for saving into it? We’ve seen in our workplace savings research that auto-saving approaches are more inclusive of those who have struggled to save previously and highly popular. Could the end-of-loan moment be a similarly successful application of behavioural support for saving?
There may also be points during a loan repayment term when borrowers could be appropriately nudged to save. For example, how would borrowers respond to a prompt to consider saving when they are halfway off paying off their loan? Would this help them whether other financial shocks whilst also paying off their existing loan?
We’re delighted to be working with two partners currently to design real-world trials exploring some of these questions, and we’re excited that we will be able to tell you more about these trials very soon…!
We’ll use the learnings from both the evaluation of credit union save-as-you-borrow solutions and the real-world trials to understand whether there are ways that joined-up borrowing and savings solutions could be optimised to enhance financial resilience, and scaled to reach more UK workers. If you would like to be involved in this work, or hear more about the learnings, please get in touch.
[1] https://www.moneysavingexpert.com/savings/pay-off-debts/.
[2] Resolution Foundation analysis of the Wealth and Assets Survey. Here, debt is any sort of financial debt (excluding student loans and ‘transitory’ credit card debt that the respondent expects to pay off before their next bill) or bill arrears. Savings are any amounts held in savings accounts, ISAs, NS&I products and informal savings.
[3] Consumer Financial Protection Bureau (2021) ‘Balancing savings and debt: findings from an online experiment’.
[4] Fairbanking Foundation (2017) ‘Save as you borrow – credit unions creating good habits’.
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