Nearly all of us are seduced into overspending at some point. You owe it to yourself to understand why you are in debt—and how to break the cycle.
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Illustration of box of "temporary happiness"
Credit: Mikey Burton

We all have debt—from the big, unavoidable expenses, such as college loans and mortgages, to the small, like a credit-card balance you racked up by charging an unexpected car repair or the holiday gifts that cost more than you could really afford.

As the January 2012 issue went to press, Americans owed more than $8.5 trillion in home-mortgage loans, nearly $1 trillion in student loans, and $789.6 billion in credit-card debt. That translates into a median household debt of more than $200,000, according to the U.S. Federal Reserve. Although our debt load has actually decreased a little since the recession began in 2007 (partly because spending is down), recent stats show that hefty loans continue to wreak havoc on our finances.

The U.S. Department of Education reports that nearly one in 10 borrowers who started repaying student loans between October 2008 and September 2009 defaulted by October 2010—the highest rate in 14 years. And mortgage lenders filed foreclosure procedures on a record 2.8 million properties in 2010 (a 23 percent increase from 2008), according to RealtyTrac, an aggregator of foreclosure data. So it’s little surprise then that personal-bankruptcy filings jumped by 9 percent in 2010.

All this debt hurts more than just our wallets; it can also damage our health and our relationships. A recent poll by the nonprofit National Foundation for Credit Counseling (NFCC) found that 24 percent of people said financial anxiety had an adverse effect on their health, and 27 percent said it had a negative effect on their marriage.

If you’re weighed down by all this debt, what’s the key to reducing it? Knowing how you got into it in the first place.

Why We’re Overextended

We’re not great at visualizing money that doesn’t take up space in our wallets. “When people spend money with a credit card, their brains process the transaction differently than if they use cash,” says Jonah Lehrer, the author of How We Decide ($15, “The part of our brain that processes payment doesn’t really understand what happens when we take the plastic out.” Case in point: A 2000 Massachusetts Institute of Technology study showed that people at an auction were willing to pay twice as much when they used a credit card instead of cash. Turns out, when you can’t see the money, it’s easier to be loose with it. This may also explain why so many of us are able to sign on to expensive mortgages and car loans relatively angst-free; the giant amounts on the dotted lines are just too big and abstract to contemplate.

We’re too optimistic. Have you ever made a to-do list for the day only to find that you severely underestimated how much time each task would take? The same thing happens with debt, experts say. It’s a phenomenon called “future discounting,” in which we tend to overstate our ability to earn large sums of money or make substantial payments down the road. “We say to ourselves, ‘I’m bound to get a raise’ or ‘I can pay this off once I receive a fat tax refund,’ ” says Kathleen Gurney, Ph.D., the Sarasota, Florida-based CEO of Financial Psychology Corporation, a consulting firm that specializes in the psychology of money. Retailers use future discounting to their benefit. Those offers touting 0 percent interest for 12 months or no money down? Merchants count on you to buy now and figure out how to pay the bill later. And if you don’t, they sock you with huge interest-rate jumps and other penalties.

We’re impulsive. Cast your mind back to the last time you hit the mall after a bad day at the office. Did you think, I work hard—I deserve something nice, or bemoan the fact that you never get a treat? Such woe-is-me thoughts can overwhelm the brain’s logic centers and lead to spur-of-the-moment buys that make you feel better. (A stunning 60 percent of all purchases are unplanned, according to Popai, a global-marketing trade association.) Unfortunately, the high is fleeting, says Gail Cunningham, a spokesperson for the NFCC, so you end up repeating the cycle over and over again.

We forget about the little things. Think about yesterday. Do you remember spending 75 cents on a snack from the vending machine, $10 on music downloads, and $6 on an umbrella? Probably not. “When you’re buying different things, you don’t notice tiny daily expenditures,” says George Loewenstein, a behavioral economist and a professor of economics and psychology at Carnegie Mellon University, in Pittsburgh.

We listen to authority figures. Let’s face it: We didn’t get into debt entirely on our own. Prior to 2008, banks, credit-card companies, and the government enabled us to borrow more and more money. (Remember how experts used to say it was always better to buy than to rent?) Aggressive marketing campaigns and loose qualifying restrictions made it easy to sign up for a walletful of plastic or receive a megasize home loan. Unfortunately, several years after the economic meltdown, consumers are still trying to figure out how to clean up their personal debt mess.