By Freakonomics
New research finds that credit-card holders pay down their debts more slowly when their statements suggest a minimum monthly installment. The Economist reports on the study, by University of Warwick psychologist Dr. Neil Stewart:
New research finds that credit-card holders pay down their debts more slowly when their statements suggest a minimum monthly installment. The Economist reports on the study, by University of Warwick psychologist Dr. Neil Stewart:
Mr. Stewart presented 413 people with mock credit-card bills of £435.76 (about $650) that were identical — except that only half mentioned a minimum payment of £5.42. Participants were asked how much they would pay. Among those inclined to pay the bill in full, the presence of the minimum payment hardly made any difference. However, those who wanted to pay just part of it handed over 43 percent less on average when presented with a minimum payment. In the real world, this would roughly double interest charges.
It turns out that, for those inclined to pay their debt bit by bit, the monthly minimum acts as a mental anchor, exerting an enormous amount of influence on how quickly that debt gets paid. Stewart found that as suggested minimums drop, actual payments fall right along with them, even among people who pay above that bottom limit. So the minimum payment can be a helpful tool for card holders. It gives them a guide on how much money to pay to keep their debt from exploding under compound interest.
But it’s a much better deal for the companies that issue the cards. Say you’re a credit card company. You make money every time one of your card holders carries a balance at the end of the month, because you charge interest on that debt. A lot of interest. The longer your card holder carries debt, the more money you make. But if that debt tips out of control, and the card holder defaults, you lose everything.
So you want to find a middle road, a strategy that will keep your card holder’s debt manageable, but that will stretch out repayment as far into the future as possible, maximizing your profits.
Considering Stewart’s findings (paper available here), minimum monthly payments seem like the most surefire way down that middle path.
Considering Stewart’s findings (paper available here), minimum monthly payments seem like the most surefire way down that middle path.
30 comments:
For me, knowing that I'm going to have to pay something out over a really long period of time would just annoy me. I would like to get it done as soon as possible!
i think that the idea of this lower monthly payment is a pretty smart move for a card company. i mean if people are stupid enough to fall for that, then why not take advantage of them?
Taking advantage of "stupid" people is a good idea? What if those "stupid" people drive us into a recession and hurt the economy that us not so "stupid" people have to deal with?
-McKay
Well you can't blame the credit card companies to take advantage of stupid people. The best thing to do is not fall under that category and pay off the bill as soon as possible! Or just don't get a credit card.
I'm gonna do what my parents did, and not borrow money if I don't need it. And once I do borrow that money, pay it back as soon as possible. Because of this, they are virtually debt free.. they have a few more house payments left.
That's gonna change next year though..
I want to try and avoid credit and debit cards as much as possible. But I'm sure that I'll have to borrow occasionally but I would pay it back as soon as possible to avoid extra charges.
Well, if people rack up their bill and don't have the money to pay for it then the credit card companies have every right to take advantage of that. If you just pay off the card each month, you can avoid any messes.
of course, the credit card complanies want to make a buck off of everyone. how else are they supposed to feed themselves? i think that if everyone just used credit cards for absolute emergencies and then paid it in full, we wouldn't have such big problems.
I think there are way to many young people especially who never get into the habit of putting money away. They think they have years to save for a family and retirement, but there are so many things they need right now. Credit Companies love these people because they are so naive to how compounding interest can work against them. While it is not ideal or possibly very moral of these companies to take advantage of them, we live in a world of selfish people who really don't care about anyone's circular flow but theirs. Resulting in the problem we have now.
Well thats the credit card companies job to make money off stupid people. People can avoid it by paying it off every month and stayin on top of it.
if you have to borrow, borrow. But if you can avoid it of course do that. And if you borrow make sure that you have a plan to pay it back as soon as possible.
it's easier to spend money on stuff you need instead of only on stuff you want. then when you need something you don't have to charge it and rack up alota debt. don't spend money unless you have it.
Just be sure that you don't charge more than you can pay. The credit card companies are smart by making money off the stupid people in the world.
credit cards are only trouble..
whether they make it easier by lower payments or not.. people will be in debt even longer then they are now.
In my opinion, there is no point to having a credit card. Most of the time, it'll just put you in debt.
When people see the minimal amount to be paid people think that that is what they should pay. If it was up to me I would try to pay it off as soon as possible.
The longer you take to pay off your debt the more your're gonna have to pay. The whole solution to this is just don't get in debt, and if you do, pay it off asap, don't min pay your way through it. How ever people don't see this and it's, like leeches, credit card companies live off of stupid people. Now that we've let this root itsself into our lives it's going to be next to impossible to get rid of. Credit was just a bad idea in the first place.
Credit cards are a great way for these companies to make money people can buy things without having to have the money right then. People's eyes get bigger than their stomachs and just like that they're in debt. It's pretty simple if you don't have the money to pay it off right then don't buy it. That way you can't get in debt. And if you must make a really expensive purchase on the card pay as much on it every month as you possibly can.
People don't usually fully understand the concept behind the credit card, through minimal payments the user may think they are getting a better deal, but in the long run that pair of shoes you bought for $200 bucks will end up to be that pair of shoes you ended up paying $600 bucks for through only paying the minimum and not in whole.
Credit cards are the worst invention of mankind. I personally don't need one, i'm a heavy spender as it is. With one of those I would be in debt over my head
Irresponsible people shouldn't have credit cards.
i agree with jamie. if you're too stupid to realize that if you can't afford to pay this month's bill fully, you probably won't be able to pay next month's either especially with the carry over from what you haven't paid...and interest.
i don't feel like paying for their bailout during a recession.
i mean seriously.
credit only works for smart people.
Credit card companies want more of cardholders' money; cardholders want to shop now and pay later. Of course the smart thing to do is pay the bill while you can, but that doesn't mean it's going to happen. It's just the way some people are.
the concept of credit sucks in respect to the fact that the best way to build credit is to use a credit card but if you dont use it with discretion you get screwed.
My parents always said that credit cards are always a last resort use of payment. For those that have bogged themselves down with debt would probably like the idea of this minimum payment stuff, but someone that wants to get the payment done and overwith probably wouldn't give a crap about this solution.
Don't ever ever ever use a credit card period........
i just wouldnt use a credit card. problem solved
well if i were the card company i would find a minimum limit to keep people paying off their debt but not to much to not keep making profit from the monthly balance interest. it is morally unsound though to trick people into a small monthly payment only to assure yourself a big interest payoff in the end. and the fun part is if they don't pay your money you get to watch their lives get destroyed by the officials and lawyers. yea for what immoral behavior can do for you!
if you dont borrow more money than you can afford to pay back it shouldn't be a problem. The problem with credit cards comes in when people start spending money that they know they dont have and just use the credit card as a way to put off the payment and basically dig themselves into deeper holes.
If you cant handle the responsiblities of keeping up with your credit cards then you shouldnt use one to start off with.
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