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Credit cards
Credit cards

Economy Lab

Credit card minimums: Why you can't resist Add to ...

Frances Woolley is a professor of economics at Carleton University



The credit card bill came through the mail. New balance: $1,676. Minimum payment: $10.

I had always thought minimum payments protected consumers from accumulating debts they could not pay. Yet research by Professor Neil Stewart of University of Warwick suggests that minimum payments can hurt consumers.

More related to this story

Suppose that I don't have enough money on hand to pay off the full $1,676 owing on my credit card. It's hard to decide exactly how much to pay. The $10 minimum payment acts as an "anchor". Just like a real-world anchor keeps a boat in one place, psychological anchors stop people from straying. People's actual payments end up closer to $10 than they would have been without the suggestion of a $10 minimum payment.

Prof. Stewart's research suggests that there is an easy way to get consumers to pay off credit card debts more quickly. In his experiment, when minimum payment information was removed from credit card statements, the mean amount repaid on credit card bills rose by 70 per cent, from £99 (23 per cent of the balance) to £175 (40 per cent of the balance). Perhaps minimum payment requirements are more about credit card company's profits than consumer protection?

But anchoring can increase payments, as well as decrease them. Charities know this well. A typical request for funds will have a line:

Enclosed please find my donation of :

$20___ $50___ $100___ $200___ Other____

Here anchors are used to suggest that a generous donation is some amount more than $200 - and one could not possibly give less than $20. Credit card bills could be designed the same way.

But given that my credit card's annual interest rate is 19.75 per cent, and paying off my new balance by making the minimum payment each month would take 14 years, why would my credit card company ever want to encourage me to pay off the balance?

Lending out money at a 19.75 per cent interest rate is highly profitable.

Follow on Twitter: @franceswoolley

 

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