Pretty much everyone with credit card debt knows that paying only the minimum due each month is a formula for disaster. But borrowers may not know that they should ignore the minimum completely.
A study by Neil Stewart, a professor of psychology at the University of Warwick in England, found that the listing of “minimum due” on credit-card bills lowered the average payments by customers. The numbers became a “psychological anchor” – an arbitrary number that serves to bias people’s judgment.
Stewart gave volunteers a fake monthly budget and a credit-card statement, having them determine how much they could afford. On average, participants paid 40% of the total amount owed. But when Stewart added a minimum payment, that average dropped to 23% of the total. “If decisions about credit-card repayments are anchored upon minimum-payment information, then people will repay less,” Stewart concludes.
The impact, of course, is exactly what credit-card companies want – more money spent on interest charges in the long term. Stewart notes that with a theoretical debt of $4,000, and a percentage rate of 20%, the experiment results would more than double the overall interest paid.
If the borrower shelled out 40%, or $1,603, a month, they would end up paying $49 in interest. Lowering that to 23% of the total, or $909 a month, the cardholder pays $109 in interest.
As you pay off your holiday gifts, then, know that in the case of credit cards, the inverse is true – a little pain, no gain.