The option to automatically pay the minimum due on a credit card sounds like a valuable tool—it makes missing a payment and incurring any related fees or other penalties far less likely. But it also makes it more likely that consumers will pay only the minimum due month after month, rather than paying larger portions of their balances. Research from Chicago Booth PhD candidate Benedict Guttman-Kenney and colleagues finds that as a result, automatic minimum payments end up costing consumers as they rack up greater interest expenses. What’s more, the researchers find it can be difficult to “nudge” credit-card holders to make larger payments—but the findings do suggest one promising solution.
Narrator: As of 2019, credit-card debt jumped over $900 billion in the US and averaged $6,300 per American household. Fully a third of credit-card holders pay only the minimum amount each month, which is typically around 1 percent of what they owe. To help reduce missed payments or defaults, many lenders offer automatic payments of the monthly minimum, but could that yield unintended consequences?
Benedict Guttman-Kenney: So in this research, we’re interested in understanding how consumers borrow on their credit cards, and in particular, why they end up repeatedly paying only the minimum. What we found was people often use what is called autopay, or in the UK, direct debit. This is a method of payment where you can set up your credit card to automatically pay only the minimum every month.
And that seems at face value a really good thing, because what it does is it means you’re never missing the amount that you have to pay, the minimum due. If you don’t pay the minimum due, then you’re going to fall into arrears. That means you might incur some extra fees, some letters, some hassle from your bank. It might even affect your credit score adversely and your future ability to access credit products.
But the flip side of that is it isn’t as good as it first appears. What we find in our data is, when people use these autopays set to the minimum on their credit card, they actually end up incurring far more in interest and fees than they would’ve done had they not had this set up.
Narrator: That’s Benedict Guttman-Kenney, a Chicago Booth PhD candidate. He worked on two teams that studied automatic minimum payments in the United Kingdom, where credit-card and customer behavior are almost identical to the US. Studying a random sample of credit-card holders from January 2013 to December 2014, they find that 29 percent used automatic payments as of January 2013. Over the next two years, 5 percent more changed from manual to automatic payments. This reduced missed payments from 12 percent to 1 percent. But borrowers became much less likely to make big payments on their total balances. Consequently, they ended up paying 20 percent more in combined interest and fees. Larger payments dropped from 40 percent of the time to 20 percent when people switched to automatic payments. Monthly payments in full dropped from 29 percent to 25 percent. This suggests that automatic minimum payments actually dissuaded customers from paying off debts, exposing them to higher costs.
Benedict Guttman-Kenney: So in our second paper, we were trying to look at ways to counter that, ways to help consumers reduce their credit-card debt and reduce the amount they’re paying in interest and fees. And the way that we did this was we partnered with a series of firms, working in my previous role for the UK financial regulator, the Financial Conduct Authority. And we ran a set of what’s called RCTs, experiments in the field. We wanted to give people some information and work out if that changes their behavior.
So these RCTs work the same way as a drugs trial. So we have a control group who experiences the same thing as they do normally when taking out their credit card and choosing how much to repay. And then we have a series of treatment groups where we’re giving them information and using insights from psychology to try and make that information really salient to them, really visually impactful. And by randomly deciding who’s in the control group and who’s in the treatment groups, we can actually work out the effect of those treatments on consumer outcomes to: Does it change their credit-card debt? Does it change the amount that they repay on their credit card? Does it change things like the amount of interest that they have to pay?
Narrator: This second experiment included billing statements that featured things like prominent graphic displays showing how many years it would take to pay off debt under alternative payment scenarios, as well as explicit encouragements to reduce the balance owed. In another experiment, lenders sent their customers communications recommending that borrowers set up automatic payments higher than the minimum payment. They included information about how much extra interest they were racking up by making only minimum payments. The lenders also randomly sent additional reminders. Two lenders reached out via letters, and the third used email.
Benedict Guttman-Kenney: So we tested these interventions across a few different lenders in the UK. This was a large set of trials, over 150,000 UK credit cards and a variety of treatments, testing things like: Does adding cost information help? Or does adding a reminder help?
The big-picture takeaway from this was, firstly, that very few people respond to these letters. Even though we did a ton of consumer research before putting these into the field and on real consumers, only one or two out of 100 actually seemed to respond to these nudges by changing their repayment choices and actually reducing their debt somewhat. But actually, in the long term, none of those changes were sustained. And if we look at debt nine months later, there’s no difference between our control group who received nothing and our treatment groups who received these nudges.
So what we take away from that is that these nudges didn’t work. And this was designed to inform regulation, and we wanted to try and find a way to help reduce people’s credit-card debts and help them make potentially better choices.
Narrator: There also seems to be a great unknown of how long it would take cardholders to pay off their debt. The researchers ran a survey asking how long they estimated it would take to pay off a typical UK credit-card balance of £1,030 at a nearly 19 percent annual interest rate, paying only the minimum payment each month.
Benedict Guttman-Kenney: What we found was people don’t understand how long it will take to repay their credit-card debt if they only repay the minimum. So 96 percent of respondents actually were wrong, and not only wrong, massively wrong in terms of years, in terms of how long they think it’s going to take to repay their credit-card debt. In truth, in this stylized example in the survey, if they only repaid the minimum, it would take them over 18 years to repay their credit-card debt. Most people are thinking in the survey it’s going to take one, two, three, maybe 10 years at most. So people have these really biased beliefs, and it doesn’t seem that the nudge is powerful enough to really counter that. We do see some effect in the survey where it is reducing their confusion somewhat, but not by enough to really change behavior. So in our survey, we also tried to understand a bit about other reasons why people didn’t repay their credit-card debt. And one reason is they just haven’t got the money. But it seems like the majority of this group of consumers potentially could pay more if there was a way to do so.
Narrator: In further experiments, the researchers tested the effects of making the minimum payment less prominent, instead emphasizing the total balance. Participants had the option of repaying in full or selecting some other amount. This dramatically changed the distribution of payments people chose and effectively eliminated their selecting exactly the minimum amount. The researchers suggested this might be the direction policy makers should take.
- Paul Adams, Benedict Guttman-Kenney, Lucy Hayes, Stefan Hunt, David Laibson, and Neil Stewart, “Do Nudges Reduce Borrowing and Consumer Confusion in the Credit Card Market?” Economica, June 2022.
- Hiroaki Sakaguchi, Neil Stewart, John Gathergood, Paul Adams, Benedict Guttman-Kenney, Lucy Hayes, and Stefan Hunt, “Default Effects of Credit Card Minimum Payments,” Journal of Marketing Research, August 2022.
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