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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.

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Reader Marcello Piraino proposes a credit card cash back program where the cash goes to charity.

Virtually every person in the western world uses either Bank Cards or Credit Cards (in many cases both) for their purchases. Whether you buy stuff from the grocery round the corner or buy a Gucci Bag for your wife’s birthday there’s an electronic transaction that takes money from your bank account and transfers it to the seller’s bank account. The nudge is, “Donate 1 cent every 1 Dollar while doing your shopping.”

Every Dollar spent will give 1 Cent to a Charity Organisation. It would need to find an agreement between (1) Card holders, (2) Banks that issue the cards or Credit Card Issuer like MasterCard and (3) Charity Organisations.

Basically, one will be donating without even noticing and, at the end of the day (or month or year) a significant amount will be given to help someone else out. You can do the maths yourselves to see the nudge potential.

Shops should sponsor that because it could increase their business, Government and banks should sponsor that too because encourages even further the use of electronic transaction thus reducing the need for printed money (I can think of other advantages but it is not really important). Regularly, a statement of the donations made could be delivered to the card holder and the donations could be used to obtain a tax reduction.

One percent is typically the number that credit cards advertise as the amount of total purchases that they refund to customers, but there is nothing special about the number. A credit card company could allow customers to designate an extra 1-5 percent of purchases to a charity of their choice.

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Just as Americans are beginning to show some restraint with their credit cards, reader Rory Sutherland sends along an idea for a card that doubles as a credit card and a charge card. He says he proposed the idea to an as yet undecided American Express.

Create a card with two PINs. If you use one PIN at time of purchase (eg. 1234) the card acts as a credit card and you have the option of revolving at the end of the month. Use the second PIN (eg. 4321) and it acts like a charge card; you will be expected to pay that expense in full when the bill arrives.

You have hence created a hybrid card, half credit card and half charge card. The difference is one has an option not to be tempted to revolve at point of purchase, not only at point of payment. Hence you may sensibly revolve long-term purchases such as furniture or PCs. Meals out, however, you would sensibly pay off in that month. But my hunch is that people’s self-control and good intentions are better at moment of use than at moment of payment, by which point all one’s purchases have been aggregated into one single, and unexpectedly large bill.

This system would mean you would pay interest when it makes sense and not when it doesn’t. Yet it imposes no constraint on the card holder at all – it merely adds an extra layer of choice and control. You could also impose restrictions on the card – voluntarily – when you first signed up, and could revise these annually: eg. prevent me from revolving on purchases below $100.

As an added piece of choice architecture, the credit card PIN could be longer and more complicated than the charge card PIN.

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A California woman devised a commitment strategy (or maybe just a bribe) with her kids to keep them debt-free and teach them finance lessons for life. (From New York Times letters section.)

I made a deal with my kids when they went to college. I would pay all their expenses, but they could not have credit cards until they had full-time jobs after graduation. The criticism from friends was that my children would suffer for lack of a credit history. But debt history can be a lifelong problem. The best credit history one can have is a sizable savings account balance.

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From U.S. News and World Report:

(At a Congressional hearing in April, Susan) Wones expressed frustration that her card company, Chase, had approved her purchases even after she went over her credit limit, triggering a fee and an interest rate hike. She had assumed charges would be denied as soon as she reached her $2,000 limit. Chase says that most customers appreciate the ability to go over their credit limit but that consumers can request to have such charges denied.

Thaler and Sunstein have proposed that credit card companies ask consumers whether they want to be able to exceed their credit limit (for a penalty) or if they would prefer the charges be denied.

If you are a shopaholic with self-control problems, you might also pay a credit card company a small amount to cancel all charges on specific categories of goods once a pre-set budget limit is reached each month. For instance, Thaler has a weakness for good wine, so he might ask his credit card company to reject all charges from liquor stores and online wine shoppes after X dollars are spent. Sunstein has a weakness for books, so he might ask that all charges to Amazon or Barnes & Noble be rejected after he spent Y dollars on them for the month. Is there a store or product for you wish your credit card company could help you control your spending?

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