Why People Mismanage Credit-Card Debt
- September 06, 2017
- CBR - Economics
Where credit is due
Consumers carrying balances on two credit cards with varying interest rates tend to pay off the cards more evenly than is optimal.
The researchers looked at 100,000 individuals in the United Kingdom who held a revolving balance on two credit cards over a two-year span. The average difference in interest rates between the two cards was 6 percentage points.
On average, the amount people paid monthly toward their higher-interest card was £259, only marginally more than the £230 paid toward the other card. The researchers calculate that, after paying the minimums, individuals should have allocated 97 percent of the remaining payments to the higher-interest card, although in practice they actually allocated 51.5 percent to that card.
Gathergood, Mahoney, Stewart, and Weber consider a number of explanations, including that people could be repaying the credit card with the highest capacity, the highest balance, or the lowest balance. They pit these explanations against their own theory, “balance matching,” in which payments are proportionate to overall amounts owed.
Using statistical approaches, the researchers find that it’s far more likely that people were engaging in balance matching. “Consistent with the balance matching results, the machine learning models confirm that balances are hugely important for predicting behavior,” they write. The other explanations predict people should concentrate on repaying a single credit card, but the data suggest people instead juggle multiple debts—focusing on high balances rather than high interest rates.
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