Researchers from the Norwegian School of Economics and the University of Chicago have published a new paper in the Marketing Journal which examines the minimum payment requirements of credit cards affect consumer decisions about how much to pay for each debt account.
The study, to appear in the Marketing Review, Is titled “Minimum Payments Change Debt Repayment Strategies on Multiple Cards” and is written by Samuel Hirshman and Abigail Sussman.
Many Americans have received stimulus payments related to COVID. With nearly $ 800 billion in outstanding credit card debt in the United States, many consumers say they plan to use those payments to pay off their debt. However, the best way to do this is not easy. Most indebted households have to choose not only how much to pay off debt, but also how much to pay off. How does a common reimbursement boost, the minimum payment required, affect the decision of how much to pay for each card?
Researchers find that minimum payments cause consumers to distribute repayments more evenly across debt accounts, even after factoring in the minimum payments themselves. They call this the “dispersion effect of minimum payments”. While this model may seem harmless, it leads consumers to pay off their debts less at the highest interest rates and pay more interest overall. In other words, consumers end up spending more than they need to pay off their debts.
While there are likely several causes for the dispersion effect, a key factor is that consumers tend to interpret minimum payment requirements as recommendations to pay more than the minimum amount.
Since credit card companies and regulators need minimum credit card payment requirements, an important question is whether we can help consumers improve their reimbursement choices. Hirshman and Sussman suggest that, even with minimum payment requirements, the way companies display interest rate information to consumers can accentuate or minimize the dispersion effect.
The study uses several experiments to show how different ways of displaying this information affect reimbursement decisions. For example, one type of display mimics standard paper credit card statements where attendees must search for credit card account information. This version leads consumers to pay the most in interest charges. In contrast, another type of display that gives consumers default choices of minimum payment, total debt, or “other” amount has dramatically improved consumers’ repayment strategies over paper statement. When using this version, people allocate more money to their debt at the higher interest rate and distribute the money less evenly across accounts.
The research has implications for policymakers, consumer advocates, and businesses striving to improve the financial well-being of consumers. First, businesses may have the ability to help consumers pay less interest by aggregating information about their credit card debt. As Hirshman explains, “Our results suggest that consumers tend to focus on interest rates when making allocation decisions, but not doing enough. One contributing factor is the minimum payment, but we also provide evidence that making interest information more readily available is also helpful. “
Second, the market can provide financial technology products to save consumers money. “For example,” says Sussman, “consumers can save money by paying a single amount to a business and then asking them to use that lump sum to pay down debt on multiple accounts. Due to the high interest rates on credit card debt, even paying a fee to the business can lower costs for consumers. Some companies like Tally already offer versions of this service.
Third, the study documents an additional cost to the financial well-being of consumers of having multiple debt accounts. There has been a recent push to use both big data and surveys to map the financial health of consumers. Due to the scattering effect, the number of a consumer’s credit card debt accounts and the extent to which they are focusing their payments on their highest interest debts can be useful metrics to add to these efforts. .
Finally, when policymakers consider changes to credit card statements, this study suggests it’s important to pre-test how consumers interpret the changes. Nudges used by policy makers can affect consumer decision making unintentionally. This will allow policy makers to produce the desired effects while avoiding unintended consequences.