Avoid ‘anchoring’ yourself to prolonged credit card debt

30th November 2011  

We love our credit cards in the UK. Second only to our cousins on the other side of the ‘Pond’ in terms of credit card expenditure, many Brits think nothing of piling on the ‘buy now, pay later’ debt. But as long as you pay the minimum payment every month, you’re gradually chipping away at that debt.

You’ve made the right decision, based on the facts available. Or have you?

Recent research suggests otherwise. By law, every monthly credit card statement has to have a minimum payment printed on it and, unbelievably, it seems that’s what most people pay. Consumers think it ensures that the debt doesn’t spiral out of control by making sure that you pay at least some of the debt off each month.

The truth is that the vast majority of that ‘minimum payment’ actually goes towards paying the interest charged on the loan, and that only a very small percentage goes on the outstanding balance. Yet every month, we’re ‘anchored’ into this behavioural spiral of paying only the minimum amount. Prof. Neil Stewart of the University of Warwick suggests that this behaviour is part of a psychological pattern that could prolong the period of debt considerably.

What is ‘anchoring’?

Put simply, anchoring is the effect that irrelevant numbers have on the behaviour of people, and how it can bias their judgement. Simply by reading the suggested minimum payment effectively encourages us to pay off less than we would otherwise have done. While this sounds counter intuitive, it does have some comprehensive science to back up the theory, including a detailed study by MIT researchers in the US, as well as Prof. Stewart’s recent work.

Prof. Stewart believes that this psychological phenomenon is something that should concern responsible lenders, because it distorts the behaviour of customers in a way that increases interest charges and prolongs the duration of the debt. The results of two detailed studies concluded that the level of repayment actually made by cardholders was closely related to the stated minimum payment. While those who paid off the balance in full seemed to be immune to this auto-suggestive behaviour, even those who paid off more than the minimum monthly suggestion were guided by it. The lower the minimum suggested payment on the statement, the less people paid.

Other factors

Obviously, the amount paid also has much to do with the amount the customer can actually afford to pay. But it seems that the anchoring effect effectively skews a customer’s perception of that amount, subconsciously forcing them to make a lower payment than they would normally. While a suggested minimum payment is important to ensure a credit card debt doesn’t incur additional penalty charges through underpayment, this research does suggest that financial lenders haven’t taken the dangers of anchoring seriously. Credit card issuers make their profits on the interest charged on loans, so theoretically it is in their best interests to prolong the term of the loan.

But in the interest of fairness, Prof. Stewart suggest that the warning text that accompanies minimum payments on credit card statements should also highlight the dangers of anchoring too. Helping people to understand how this phenomenon effects their behaviour could mean they avoid anchoring on minimum payments, and result in a more accurate estimation of what they can really afford to pay every month. And that’s got to be a win-win scenario for everyone.

Enjoyed this Post?

Subscribe to our daily post, Follow us on Twitter, Join us on Facebook

Follow us on TwitterJoin us on Facebook
Recommend this post

Simply give this post a vote on Google+, Facebook or Twitter to tell your friends

Follow us on FacebookFollow us on TwitterSubcribe to Compare credit cards feed
Subcribe to Cardchoices email alert