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After declining during the Great Recession, credit-card borrowing in the United States has rebounded over the past decade. The amount owed on cards in 2019 stood at more than $900 billion and averaged $6,300 per household and represented the main form of unsecured borrowing by US consumers.
To help protect borrowers from forgetting to make a payment or defaulting, lenders enable them to schedule automatic payments. A common automatic payment option tends to be paying the minimum each month, an amount that is low—typically just 1 percent of a balance. As many as a third of credit-card account holders regularly pay the minimum amount, data show.
Chicago Booth PhD candidate Benedict Guttman-Kenney worked on two teams that studied how costly the use of automatic minimum payments are in the United Kingdom, where the credit-card market and consumer behavior are almost identical to those in the US. The results are discouraging. One study finds that enrolling in automatic minimum payments deflated any pressure on consumers to pay up. The other suggests that nudges encouraging people to kick in more each month have little to no effect.
“We calculate that 8 percent of all interest ever paid on credit cards is due to using automatic minimum payments,” says Guttman-Kenney.
In the first of the UK studies, the researchers analyzed the effects of automatic minimum payment options on a random sample of credit-cardholders from January 2013 to December 2014. The anonymized data, provided by Argus Information and Advisory Services, included card identifiers, balances, required minimum amounts, purchase amounts, purchase types, repayment amounts, fees, and finance charges.
Only a minority of UK consumers use automatic minimum payments, says Guttman-Kenney. However, if you take all cardholders who pay the minimum nine or more times in a year, 75 percent of them make automatic minimum payments. Such a pattern of repeated minimum payments is important to study, as it means these consumers are barely reducing their debt balance and meanwhile are incurring high interest, the researchers write.
In the study sample, 29 percent of cardholders used automatic payments as of January 2013, and another 5 percent changed from manual to automatic payments over the next two years. For those who switched from manual to automatic, the proportion of missed payments fell from 12 percent a month to 1 percent.
When cardholders switched from manual to automatic minimum payments, they became much less likely to miss a payment, but also less likely to make a large or full payment.
But while these cardholders avoided late payment charges, the benefit was far outweighed by the extra interest charges they racked up: 20 percent more in combined interest and fees. These extra charges occurred because after switching, cardholders neglected to make the occasional larger payments they previously had, the researchers find. While previously cardholders had made larger (more than the minimum) payments 40 percent of the time, that dropped to 20 percent. Meanwhile, the proportion of monthly payments made in full dropped from 29 percent to 25 percent.
And it’s hard to nudge consumers using automatic minimum payment plans to make choices that would reduce their debt. In the second study, researchers investigated why people make minimum payments and tested whether certain disclosures and nudges could help reduce the debt of such cardholders.
In one experiment conducted between 2016 and 2018, they presented enhanced versions of the disclosures required on US credit-card statements, which specify how many years it would take to pay off debt under alternative payment scenarios. While these disclosures have been found to be ineffective in the US, the researchers wanted to test their effects in the UK, where they’re not mandated. They collaborated with a UK lender to create nudges that went beyond the US disclosures by explicitly encouraging cardholders to reduce their debt. The nudges, which appeared on the first page of each billing statement for almost 30,000 cardholders, had no effects on changing credit-card debt, the researchers find.
A second experiment involved about 150,000 UK credit-cardholders making automatic minimum payments across three lenders. Working with the researchers, the lenders recommended that borrowers set up automatic payments exceeding the minimum amount and included information about how much extra interest they were paying by making only minimum payments. The lenders also randomly sent additional reminders. Two lenders reached out via letters, and the third used email.
The researchers find little to no effect on credit-card debt. For cardholders who received a letter or email notification, just one or two out of any 100 cardholders, on average, responded by enrolling in automatic fixed payments that exceeded the minimum, the researchers find. While the nudges initially appeared to increase average payments and reduce credit-card debt, such gains were not sustained over time.
Instead, it appears that the nudges brought forward the timing of manual payments—made in addition to the automatic payments—rather than changing the cumulative amount of repayments and outstanding debt. Adding a reminder had some evidence of lowering debt, but it was not replicated across lenders and was not robust across outcome measures.
Following the experiments, the researchers surveyed the cardholders, asking among other things how long it would take, while paying the minimum, to pay off a typical UK credit-card statement balance of about £1,030 at a nearly 19 percent annual interest rate. Respondents underestimated the time it would take to clear the debt. (The correct answer was nearly 19 years.)
It appears some consumers understood and remembered the nudges but weren’t swayed powerfully enough by them to change their behavior, the researchers conclude. It’s possible that some consumers paid the minimum because they didn’t have enough cash on hand to pay more, but the researchers find that only 19 percent of survey respondents reported that they struggled to keep up with payments or were falling behind. And when asked why they selected an automatic minimum payment rather than a larger automatic fixed payment, only 20 percent of borrowers said that’s all they could afford.
“We tested a variety of nudges that show people just how costly it is to only pay the minimum and provide them an alternative way to automatically pay more than the minimum,” says Guttman-Kenney. “But the nudges don’t work at changing economic outcomes.”
This highlights a challenge for consumer financial protection regulators: if disclosures and nudges don’t work, what will? They’re left, says Guttman-Kenney, with a difficult choice between more intrusive policies restricting consumer choice—which may have larger unintended consequences—or doing nothing at all.
- 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, forthcoming.
- 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, December 2021.
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