We’ve all done it. Standing in a store weighing up a purchase. “Can I afford this?” we think as we reach for the credit card. It’s a pattern that repeats in stores everywhere and our reply of “yes” is easily explained. Optimism bias shows up when we are deciding whether or not to make a purchase and if we can really afford it.
Optimism bias is the inability to accurately estimate our ability to make future repayments, specifically, overestimating out ability to repay borrowed cash. This is particularly bad in Australia given our ‘she’ll be right’ attitude to most things in life and reflected in our collective $32 billion credit card debt.
When deciding whether or not to buy something on our credit cards, Australians are less hesitant to spend with reason and more willing to create a debt they will struggle to get out of.
Borrow only what you know you can afford to repay
It is important to know your budget and financial position well, and be realistic about it. Look at the figures honestly and decide how much you can afford to repay.
What you can afford to borrow and being able to meet the minimum repayments each month are two entirely separate issues. Only just scraping together a minimum repayment on a loan or your credit card each month is not a sustainable way to be managing your finances.
Just because you can find the money this month, if something happens next month that leaves you unable to earn an income you will struggle to keep up with the debt created by your employed lifestyle. The consequences of missing repayments become real very quickly and may not give you time to get back on your feet.
Factors to take into consideration when spending borrowed money
When placing items on credit cards, thanks to optimism bias, we can have the best intentions to repay the card off in full and neglect to think about the interest rates charged if the balance isn’t paid off in full each month. Be realistic about your capacity to pay this credit card bill in full and take into consideration how much that item will really cost you after interest is added to it.
Know exactly how much money you have coming in, and how much of that you have available to spend on life’s extras. Be strict in sticking to your budget and spending only what you can afford to pay for in full.
Do you have a large expense coming up that you know will limit your ability to repay a larger credit card bill? Having a solid idea about what is coming up in your budget means you can make more informed financial decisions that put you in a better place to pay off your debts.
Struggling to get your debts under control? Life After Debt can help. Contact our team of experts on 1300 237 669 or via email here and regain control of your finances.