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How minimum payments on your credit card affect how much you pay

minimum payments

About three quarters of credit-card accounts attract interest charges. In the United States, credit-card debt is $951.7 billion of a total of $2,539.7 billion of consumer credit. In the United Kingdom, credit-card debt is £55.1 billion of £174.4 billion of consumer credit. The 2005 U.S. Bankruptcy Abuse Prevention and Consumer Protection Act and the 2003 United Kingdom Treasury Select Committee’s report require lenders to collect a minimum payment of at least the interest accrued each month. Thus, people are protected from the effects of compounding interest. However, including minimum-payment information has an unintended negative effect, because minimum payments act as psychological anchors.

In anchoring, arbitrary and irrelevant numbers bias people’s judgments and decisions, even when participants know that anchors are random or implausible. Meaningful anchors also bias judgments. If decisions about credit-card repayments are anchored upon minimum-payment information, then people will repay less than they otherwise would and incur greater interest charges. Consistent with this hypothesis, I found a strong correlation between minimum payment size and actual repayment size in a survey of credit-card payments.

Source: “The Cost of Anchoring on Credit-Card Minimum Payments” from Department of Psychology, University of Warwick