credit cards

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You are a consumer looking for a credit card. Good news – There’s lots of choices out there. Ultimately, the feature that is going to determine the “price” of the card is the interest rate. The lower the interest rate, the less the card will cost (put aside added complications around annual fees and scenarios where two cards have the same interest rate but different credit limits).

Bad news – Interest rates are abstract ideas. Assessing the costliness of, say, a 2.4 percent APR difference on your credit card bill is not a simple calculation, especially when your spending and payment patterns fluctuate. Plus, paying back interest will happen later. Much later. Consumers are thinking about the present. What can I buy with this card? Throw in some overconfidence. Your past track record of repayment may not be as good as your expected track record in the future. What you end up with is credit card companies that have no need to compete on interest rates since that’s not how the average person is going to pick a card. So what do they compete on?

Reward programs (those are all the rage now).



The simplicity of those reward programs.

Ability to use this card in more places.



Social proof.

Identity (and social proof).

Ease-of-use.



Exclusivity.

Celebrity pitches.

Sweepstakes.

Security.

In other words, everything but interest rates. Puzzling indeed.

Addendum: Here’s a Capital One commercial for a “personalized” card with the option to pick a “low interest” rate. Of course, the real draw seems to putting a photo of your pet on the front.

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Brown psychologist Steven Sloman asked his students to propose a social policy nudge grounded in behavioral science. “It turned out to be harder than expected for students to decide what counted as a nudge as distinct from a shove,” he writes the Nudge blog. “But they all succeeded in the end.” Students proposed nudges for presenting the uncertainty associated with diagnoses of mental disorders, for rationalizing the rate “at which investors sell winning and losing stocks,” and for making the expense of cigarettes and the wastefulness of leaving the tap on more salient. Sloman sends along an account of three nudges that are noteworthy for “their simplicity and their strong scientific roots.”

1. Paige Kirstein proposed a nudge to reduce use of bottled water in fast food restaurants. Her idea is that tap water should be displayed prominently on menus beside bottled water either with a price of “free” or with a nominal charge for the cup that it is served in. Paige argued that customers will increasingly choose the tap water with consequent benefits to the environment because of the direct contrast to bottled water.

2. Maia Kipman proposed an automated system to induce drivers not to text while driving (estimates are that 66% of drivers 18-24 years old practice this dangerous habit!). Maia’s system would put the phone in a special mode when the vehicle is in motion. In this mode, the telephone would work normally but incoming text messages would not be heard. Once out of the car, the phone will inform the driver if they have a message. The phone will automatically let the sender of the message know that the driver is busy and cannot attend to their message but will respond shortly. Finally, if the driver tries to send or read a text, the system would play a recording by a celebrity suggesting that doing so is not a good idea. For instance, Maia suggests that Bill Maher might be induced to record a message that says “New rule: No killing people ‘cuz you are too self-involved.” She thinks it’s important that the message change frequently and hopes that the general public would get involved in generating such messages.

3. Aaron Foo proposed a whole series of nudges to get consumers to stop abusing credit cards. One of his ideas was similar to that of another student, Chloe Swirsky. Their proposal is to take advantage of mental accounting and prior commitment to get consumers to commit to spending limits for various categories of expenditures at the beginning of each time period. The credit card company will place each expenditure in one of those categories and enforce the spending limit. For instance, if the consumer decides that they do not want to spend more than $50 on fast food that month, then the credit card will not work in a fast food location after $50 has been spent.

For a past Nudge in the classroom, click here. To professors and students working on nudges in their classrooms, please share your stories with us.

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New federal rules on credit cards are hitting this summer. Banks will no longer be able to automatically let customers withdraw more money than have in their checking accounts (for a nice fee) when they use their debit cards. Overdraft coverage will still be an option, but consumers have to sign-up for it. Banks will be busy sending out letters explaining the virtues of overdraft protection, but non-responses are treated as no’s under the new rules.

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Nudge blog reader and Booth School grad Faysal Mokadem thinks there is a way to reframe credit card statements to keep people from overspending. Instead listing the balance as a positive amount, Mokadem wants to list it as a negative.

For instance, say I have a credit limit of $10,000 and I have spent $8,500 throughout the month. Usually a credit card statement would read: – Credit $8,500. Available balance $1,500. This lets people feel that they have room to spend…

What if I had the following statement: You are -$8,500 and you can go down to -$10,000.

Framing the statement this way makes feel that you should move up to zero, rather than trying to stay below $10,000.

Mokadem says he tries to read his statements this way in order to motivate himself to keep his debt down. “Instead of feeling that I have a right to spend up to my available balance, I feel that I am under water or really in debt,” he says.

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1) Should perspective home buyers be required to watch a video about the pain of foreclosure before they qualify for a mortgage? Draft a budget? Pass an exam about loans?

2) Stefan Wobben reports on deceptive marketing defaults online; one for RyanAir and another for the Wifi at the Amsterdamn airport.

3) NIH is looking to give two $7.5 million grants to investigate health care nudges. Application here. Hat tip: Dan Goldstein.

4) Extremeness aversion and Starbucks coffee.

5) Before credit cards were accepted in cabs, New York riders averaged a 10 percent tip. Now that cabs allow cards, tips have jumped to an average of 22 percent. Hat tip: Steven Shechter.

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Barry Ritholtz takes note of an ongoing battle between retailers and credit card companies over the processing fee that credit card companies take from retailers with each consumer purchase.

An increasing number of stores have changed their default card settings to “Debit” from “Credit.”

I first noticed this during a visit to Target. I swiped my bank debit card — also a Visa — thru the machine. Sometime ago, the default setting was Credit, but now it seems the default setting was Debit.

So too is the default setting at the Supermarket. If you wanted cash back, you previously had to select Debit, than punch in a dollar amount. Now, the default is debit, and you are automatically asked if you want cash back (some consumer groups advocate sticking with credit over debit).

Addendum: @ Jon. Hilarious.

Addendum Too: Reader David Glenn passes this observation along: “Lately the price of gasoline advertised along I-95 in the northeastern U.S. can be a low (for here) $1.64. But when you pull up to the tank, the default price is a cash only price. The credit card price might be $1.79 or higher for regular. The default option has switched from credit to cash, but the advertised price has not kept up!”

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Reader Aaron Keating writes in with two interesting and thoughtful ideas on ways that credit card companies could nudge their customers to manage their credit better.

The social and economic problems caused by excessive credit card debt are widely known. Below I’ve outlined two default choices currently used by most credit card companies, and suggest nudges that could help consumers rein in excessive credit card use, minimize future credit problems, and use available credit more wisely.

1. “Suggested” vs. “Minimum” Payments

Credit card statements are required by law to require a minimum payment that includes a small percentage (2%-4%) of the principal carried on the card, as well as the interest accrued to date. Depending on the balance carried, the minimum payment can be as low as $10. But as recent research has noted:

“…although minimum payments are designed to protect consumers from the effect of compounding interest, they actually act as “psychological anchors”. In other words, when people are assigned a minimum amount, they generally pay less than they would have if no amount had been listed. A lower payment results in greater interest payments as the debt accrues. If this is the case, the laws that are supposed to protect consumers are unintentionally providing a greater barrier to avoiding credit card debt.”[1]

To combat this problem — while preserving individual choice about payment amounts — I suggest credit card companies present a different default payment option to consumers when the total balance exceeds a predetermined amount, as follows:

If the total balance is small enough that by making the minimum payment the balance would be paid in full within one year, the credit card company calculates and display the minimum payment due as it does now. However, two other pieces of information are also shown: the number of months remaining before the balance is paid in full at that payment level, and the total cost, including interest, the consumer will pay by the end of that time period.[2]

If the total balance is large enough that the minimum payment is not sufficient to pay the balance within one year, a second payment choice is also presented: the “suggested” payment, which shows monthly payment required to pay the balance in full (with interest) in 1 year. As noted above, the number of months remaining before the balance will be paid in full, and the total cost the consumer will pay over that time period (with interest) are also displayed.

If the total balance is large enough that the minimum payment is not sufficient to pay the balance plus interest within 1 year, the “suggested” payment, months remaining, and total interest information could reflect a 2- or even 3-year repayment plan. But for those consumers with credit card debt levels high enough that their minimum payment won’t pay the balance within three years, a brief sentence suggesting they contact a local, non-profit credit counseling agency – along with the agency’s name and phone number – should be included with the credit card statement.

Presenting a “suggested” payment alongside the minimum amount due, with information about the outcomes of each choice, will provide two defaults from which consumers can choose. By highlighting the consequences of their choice and making outcomes easily comparable, consumers can be gently encouraged to pay off their cards sooner and avoid overextending their debt.

2. Opt-in to Credit Limit Increases

Credit card limit increases are often opt-out by default; consumers receive a letter from their credit card company informing them their credit line has been increased. An opt-in process should be used instead, so consumers can actively choose whether they wish to extend their credit lines.

Information about a proposed credit card limit increase should also include the total number of months required to pay the full balance of the card at the proposed new credit limit, using the minimum, one-year, and three-year payoff levels as outlined in #1 above.

Consumers would still be free to contact their credit card company to request an increase if they need it, and credit card companies would still be free to offer increases – but the information noted above will provide some context for the consumer’s decision, and ensure the choice to extend a credit line is conscious and deliberate.

These two suggestions would serve the consumer’s interest in credit management more effectively than policies currently in use by most credit card companies. The new defaults may cause smaller profit margins for credit card companies in the short-run, but improving economic and community stability for individuals, communities and the nation as a whole will benefit all consumers and businesses – credit card companies included – over the long-term.

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Assorted links

1) Pepsi is calculating the carbon footprints of popular food products like Tropicana orange juice, Quaker granola bars, and Pepsi cola. No plans yet to put those footprints on its boxes, a la Sapporo.

2) More on credit cards. Companies will change interest rates depending on where you shop. They call it behavioral financing. The minimum payment acts as an anchor, but companies don’t want to anchor you on such a low number that you pile up so much interest that you go bankrupt. They want to push your debt load right up to the penultimate straw that breaks the camel’s back. Ahem, yours.

3) A Council of Economic Advisers? How about a Council of Psychological Advisers, says one psychologist.

4) A German group adapts the fly-in-the-urinal idea to Bulimia. Reducing it, that is. Hat tip: John Hsu.

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Jeff Sovern, of Public Citizen’s Consumer Law and Policy blog smartly picks up on a nudge in FDIC rules on credit card standards. Buried within Regulation Z is a requirement that the late payment warning must be located adjacent to the payment’s due date. The warning explicitly states what many people willfully choose to ignore: Failure to pay on time will result in penalties! (A mock credit card statement showing how this will look is here.) Placing this warning close to the payment amount “appears likely to increase its effectiveness,” without ordering smart consumer credit choices. Sovern continues:

I gather that this nudge, together with another, the nearby “Minimum Payment Warning,” which gives consumers information about how long it will take to pay off balances if they make only the minimum payments, are products of the 2005 bankruptcy legislation.

Hopefully, there will be a good academic paper on this subject soon. For more on the reasons behind the 2005 legislation, you can read Federal Reserve Baord Governor and subprime soothsayer Edward Gramlich’s congressional testimony. The imprints of behavioralism are all over it. The key passage:

The question is…how might the Board revise its rules under (the Truth in Lending Act (TILA)) in a way that will enable consumers to more effectively use disclosures about the key financial elements of a particular credit card over the life of the account? Simplifying the content of disclosures may be one way; finding ways to enhance consumers’ ability to notice and understand disclosures may be another. Reviewing the adequacy of TILA’s substantive protections is a third, and the ANPR asks questions about each of these areas. As the Regulation Z review proceeds, the Board will be grappling with the challenge of issuing clear and simple rules for creditors that both provide consumers with key information about complicated products (while avoiding so-called “information overload”) and provide consumers adequate substantive protections, consistent with TILA.

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Jim Heskett of Harvard Business School asks two questions over at HBS Working Knowledge.

1) Can housing and credit be “nudged” back to health?

2) Did human frailty cause this crisis (as Sunstein and Thaler have suggested)?

Readers weigh in here.

Hat tip: Mostly Economics.

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