Default Effects of Credit Card Minimum Payments

Hiroaki Sakaguchi,Neil Stewart,Stefan Hunt,Paul Adams,Lucy Hayes,John Gathergood,Benedict Guttman-Kenney

doi:10.1177/00222437211070589

Abstract

Credit card minimum payments are designed to ensure that individuals pay down their debt over time, and scheduling minimum automatic repayments helps people avoid forgetting to repay. Yet minimum payments have additional, unintended psychological default effects by drawing attention away from the card balance due. First, once individuals set the minimum automatic repayment as the default, they then neglect to make the occasional larger repayments they made previously. As a result, individuals incur considerably more credit card interest than late payment fees avoided. Using detailed transaction data, the authors show that approximately 8% of all of the interest ever paid is due to this effect. Second, manual credit card payments are lower when individuals are prompted with minimum payment information. In an experiment, the authors test two new interventions to mitigate this effect—a prompt for full repayment and a prompt asking those repaying little to pay more—yielding large counter effects. Thus, shrouding the minimum payment option for automatic and manual payments and directing attention to the full balance may remedy the unintended effects of default minimum payments.

Highlights

We explore the effects on repayments of switching to a default minimum automatic repayment
In additional analysis using linked geodata we find there are socio-economic differences between those switching to full automatic repayments and those switching to minimum automatic repayments
The main estimates from the single hurdle difference-in-differences are illustrated in Figure which plots the coefficient estimates and 95% confidence intervals for Switcher×Months from Switch interactions for the dummies from five months before switching to minimum automatic repayment through to five months after the switch, shown on the x-axis

Summary

Introduction

Designed to protect consumers from spiralling debts and ensure that credit card companies receive a flow of payments, credit card minimum payments are designed to suppress levels of debt and, in the case of automatic minimum payments, provide a form of insurance against forgetting to pay. Credit card holders can choose from a range of levels of repayment, such as the full balance on their credit card, a fixed sum of money, or the minimum payment due. They can choose to make payments manually each month, or set up an automatic payment (with the option to manually pay more on top each month). While in theory minimum payments reduce the level of debt, and automatic minimum payments minimise forgetting, in practice there may be unintended outcomes

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Results

Conclusion