A new study published in the American Economic Review by Alejandro Martínez-Marquina, assistant professor of finance and business economics at USC Marshall, shows how individuals’ reluctance to hold debt influences their investment choices and the broader opportunity costs associated with such behavior.

As many already know, debt is pervasive in the United States. Whether you buy a house, attend college, or become an entrepreneur, most major investment decisions require access to credit. A 2015 report from Pew found that 8 in 10 Americans hold debt, and nearly 70% view debt as necessary even if they prefer not to have it. However, despite its ubiquitous presence, recent empirical evidence shows the opposite: people are reluctant to take on debt when they should and may try to get out of debt instead of investing in higher-return opportunities.

While behavioral literature has primarily focused on explaining excessive borrowing, it has not been equally successful in providing a reason why people are not borrowing enough.

In a series of online experiments, the researchers had participants manage virtual accounts with varying interest rates and balances over a week. Participants were randomly assigned different debt levels, allowing the researchers to observe how debt influenced their decisions. The primary aim of the study was to assess whether participants prioritize paying down debt over investing in accounts with higher returns.

The findings reveal significant evidence of debt aversion. First, one-third of participants exhibit a strong focus on repaying debt, even when better investment opportunities are available. Second, there is widespread borrowing hesitancy. When given the chance to borrow, participants are 50% less likely to do so if it involves taking on debt as opposed to when it implies withdrawing savings, even when borrowing would clearly lead to a financial gain.

Using their evidence, the researchers estimate that participants value a dollar less in debt compared to saving an additional $1.03. While this difference might seem small, it has significant implications for investment and borrowing behavior. In particular, this bias implies that people will be willing to borrow for a 10% guaranteed return only if the interest on debt is smaller than 6.8% — or, in other words, a more than 300 basis point difference.