Credit card minimum payment amounts have an anchoring effect on many consumers’ repayment schedules. According to Neil Stewart of the University of Warwick, if you don’t pay the full amount every month or always pay just the minimum, your repayment level is correlated with your card’s minimum payment. Interestingly, among partial payers, the mere presence of repayment actually decreased the amount sent in to credit card companies (among those who pay their entire bill each month, there was no relationship). According to Stewart’s research, which relied on observational data and an experiment that manipulated minimum payment information, about one-third of consumers may fall into this partial-payer category.
These results should be of real concern to credit card companies. Virtually all credit card statements include minimum payments. But this consumer safeguard has an unexpected negative consequence: Minimum payments distort the behaviour of many customers in a way that increases interest charges and increases the duration of their debt. Those paying off the balance in full each month seem to be immune, but anyone repaying only part of the debt is at risk―not just those making only the minimum payment.
According to Stewart’s calculations, a 2 percent reduction of minimum payments on a 20 percent APR card with a $4,000 balance quadruples interest charges. Stewart’s suggestion is the inclusion of a table of repayment scenarios with each bill. A more paternalistic policy implication of this research is to raise minimum payment rates on all credit cards, which the U.S. government pressured banks to do back in 2005. The increase from 2 percent to 3 or 4 percent (depending on the person and the card) caused some short-term pain. According to the latest numbers, though, there’s still plenty of pain to come.
A copy of the paper is available by request at Stewart’s web page.
Addendum: From the Economist:
Economists will be interested in the results. Behavioural economists advocate “nudging” people in the right direction by subtly altering the choices that they are presented with. The insistence on minimum payments is a variation on this theme. Supposedly, those confronted by minimum-payment requirements should pay at least that much. In fact Mr Stewart’s work suggests that people who would have paid a lot, paid less. In economics, as in life, nudging needs to be done carefully.