Bankruptcy

Minimum Payments Help the Credit Card Industry

By Bob Lawless

If you make only the monthly minimum payment on your credit card account, the debt has a fair chance of outlasting the expected life of the plastic used to manufacture the credit card. That may be hyperbole but not by much. Paying only the monthly minimum is a sure way into debt trouble. Credit Slips readers know that.

But, at least suggesting a minimum payment is better than no payment. Maybe not. According to an experiment by Professor Neil Stewart of the University of Warwick, the presence of a monthly minimum payment on a credit card statement caused people to pay 43% less toward the credit card debt than they otherwise would. The article is in an academic journal called Psychological Science. More accessible descriptions appear in a press release and in an article from The Economist.

The reason for this counterintuitive result is a phenomenon known as anchoring. In a famous experiment, researchers asked persons to estimate the percentage of African countries in the United Nations. The estimates varied depending on whether the person was first asked to guess whether the percentage was higher than 45% or higher than 65%. Just like the results in the experiment, looking at a number on a credit card statement anchors the estimate of what is a reasonable amount to pay. Anchoring is a powerful heuristic that affects how we all make decisions. (Note to you lawyers out there -- it also explains why you'll do better on average if you make the first offer in a negotiation.) I find that my students are often resistant to the notion about just how powerful an influence anchoring can have, but experiment after experiment shows what it can do. This latest experiment is another example.

Hat tip to Frank Venis of the University of Illinois College of Law staff for pointing the way to this.

Full post as published by Credit Slips on September 22, 2009 (boomark / email).