Why Automatic Minimum Payments Lead to Mounting Credit-Card Debts

But while these cardholders avoided late payment charges, the benefit was far outweighed by the extra interest charges they racked up: 20 percent more in combined interest and fees. These extra charges occurred because after switching, cardholders neglected to make the occasional larger payments they previously had, the researchers find. While previously cardholders had made larger (more than the minimum) payments 40 percent of the time, that dropped to 20 percent. Meanwhile, the proportion of monthly payments made in full dropped from 29 percent to 25 percent.

And it’s hard to nudge consumers using automatic minimum payment plans to make choices that would reduce their debt. In the second study, researchers investigated why people make minimum payments and tested whether certain disclosures and nudges could help reduce the debt of such cardholders.

In one experiment conducted between 2016 and 2018, they presented enhanced versions of the disclosures required on US credit-card statements, which specify how many years it would take to pay off debt under alternative payment scenarios. While these disclosures have been found to be ineffective in the US, the researchers wanted to test their effects in the UK, where they’re not mandated. They collaborated with a UK lender to create nudges that went beyond the US disclosures by explicitly encouraging cardholders to reduce their debt. The nudges, which appeared on the first page of each billing statement for almost 30,000 cardholders, had no effects on changing credit-card debt, the researchers find.

A second experiment involved about 150,000 UK credit-cardholders making automatic minimum payments across three lenders. Working with the researchers, the lenders recommended that borrowers set up automatic payments exceeding the minimum amount and included information about how much extra interest they were paying by making only minimum payments. The lenders also randomly sent additional reminders. Two lenders reached out via letters, and the third used email.

The researchers find little to no effect on credit-card debt. For cardholders who received a letter or email notification, just one or two out of any 100 cardholders, on average, responded by enrolling in automatic fixed payments that exceeded the minimum, the researchers find. While the nudges initially appeared to increase average payments and reduce credit-card debt, such gains were not sustained over time.

Instead, it appears that the nudges brought forward the timing of manual payments—made in addition to the automatic payments—rather than changing the cumulative amount of repayments and outstanding debt. Adding a reminder had some evidence of lowering debt, but it was not replicated across lenders and was not robust across outcome measures.

Following the experiments, the researchers surveyed the cardholders, asking among other things how long it would take, while paying the minimum, to pay off a typical UK credit-card statement balance of about £1,030 at a nearly 19 percent annual interest rate. Respondents underestimated the time it would take to clear the debt. (The correct answer was nearly 19 years.)

It appears some consumers understood and remembered the nudges but weren’t swayed powerfully enough by them to change their behavior, the researchers conclude. It’s possible that some consumers paid the minimum because they didn’t have enough cash on hand to pay more, but the researchers find that only 19 percent of survey respondents reported that they struggled to keep up with payments or were falling behind. And when asked why they selected an automatic minimum payment rather than a larger automatic fixed payment, only 20 percent of borrowers said that’s all they could afford.

“We tested a variety of nudges that show people just how costly it is to only pay the minimum and provide them an alternative way to automatically pay more than the minimum,” says Guttman-Kenney. “But the nudges don’t work at changing economic outcomes.”

This highlights a challenge for consumer financial protection regulators: if disclosures and nudges don’t work, what will? They’re left, says Guttman-Kenney, with a difficult choice between more intrusive policies restricting consumer choice—which may have larger unintended consequences—or doing nothing at all.