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.”
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.
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.