Why shouldn’t I look at this? Doesn’t it tell me what I should pay? The answer to this, unfortunately, is yes-it tells you how much you should pay in ways that work against your interest. Why is this? A little-known psychological trick called the anchoring effect.
I’m about to geek out on psychology, but I think it’s interesting and maybe you will as well. The anchoring effect occurs when unrelated data influence your opinions or decisions. Let me illustrate by using a well-known study as an example. In a study on the anchoring effects, two groups of people were first asked whether the length of the Mississippi River was greater than or less than an arbitrary distance (the first group was shown 70 miles while the second group was show 2000 miles). They were then asked for their estimate of its length. Not surprisingly, the second group picked a much higher estimate for the length of the Mississippi. Both groups had been “anchored” by the initial data point, even if it wasn’t realistic.
What does this have to do with your credit card payment? Simply put, credit card customers’ payment behavior is influenced by the same anchoring effects. A study by Neil Stewart at the University of Warwick tested how card borrowers who don’t usually pay balances in full respond when shown statement with minimum payment compared to those given a statement where the minimum payment is omitted. The results are predictable, but still shocking. Borrowers who weren’t shown a minimum payment actually paid 70% more than those shown a minimum. Given average interest rates, Stewart finds that this effect will get credit borrowers to pay four times more in interest over the life of their debt.
Credit card companies clearly know this. In an NPR special, Andrew Kahr details how he helped change credit card practices to reduce minimum payments from 5% to 2% to lengthen the repayment period for borrowers and increase profits.
So what should you do? First, recognize that your credit card company is not suggesting a minimum payment to be nice-they’re hoping you take longer to pay off your debt. Second, don’t base your decisions based on the minimum payment-commit yourself to paying a constant amount above the minimum and stay with that amount over time regardless of the statement minimum.
By being aware of how you respond to the bank’s strategies, you’re better equipped to get yourself out of debt.
Scott Crawford is CEO of DebtGoal.com, a do-it-yourself system for lowering your interest costs and getting out of debt. DebtGoal.com incorporates all of the techniques discussed in this post and can help users understand and get visibility to and manage their debt finances.
Tags: Consumer debt, Credit Card, Debt Paydown, DebtGoal, Minimum Payment
