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Should lenders increase credit card minimum payments?

Kelly Dilworth

Consumer advocates have argued for years that credit card issuers set minimum payments way too low, trapping people into long-term debt. When you pay only the minimum amount due, interest charges build quickly, causing your card’s total balance to balloon.

The National Consumer Law Center has repeatedly urged the Consumer Financial Protection Bureau to push for higher minimum payments on card statements so that consumers are less likely to overextend themselves.

“Tiny minimum payments and underwriting the consumer’s ability-to-pay based on these payments instead of the amount of debt, makes it too easy to get deep into overwhelming credit card debt and too hard to get out,” the Boston-based consumer advocacy firm noted in 2013.

Now, some influential writers are also arguing for higher minimum monthly payments. In a July 2016 article in The Atlantic, senior editor Derek Thompson wrote that lenders are doing cardholders a disservice by charging such low amounts on high interest cards.

“Many credit card companies offer contracts with absurdly low minimum payments, which often induces less sophisticated signers to incur large penalties for not paying off the full amount,” wrote Thompson. “These policies ‘nudge’ people to be bad savers. Rather than nudge back, consumer protection agencies should just change the rules, for instance raising minimum payments for most customers.”

There’s no doubt that the current level of minimum payments will stretch out debt and maximize interest payments. Nearly all major card issuers have policies that set the minimum monthly payment at 1 percent of the balance, plus interest.

Let’s use a typical credit card debt ($3,000) and a typical interest rate (13 percent) for an example, and use our minimum payment calculator to figure it out.

Ouch. Paying just the minimum, the consumer would need more than 13 years to pay it off, and would pay nearly double the amount borrowed by paying $2,666 in interest.

But will raising minimum payment requirements help push consumers in the right direction and encourage them to pay off larger portions of their bills? Researchers have looked into the question and have, so far, come up with mixed results.

A frequently cited paper published in 2009 in the journal Psychological Science found that minimum payment amounts do, in fact, encourage people to pay less money toward their debt — in part by causing people to become fixated on the suggested number.

“Including minimum repayment information has an unintended negative effect, because minimum repayments act as psychological anchors,” wrote study author Neil Stewart. When people see an amount listed on a statement, they tend to write checks or enter figures that are identical or close to that figure. When they don’t have a required or suggested payment amount, they tend to pay significantly more.

But when card issuers increase the minimum payment — as most big card issuers have done in recent years — not everyone responds positively. Research has shown that some people react to larger minimum payments by paying off more of their balances. But others slow down their credit card payments, despite the negative effect on their debt.

In 2013, for example, researchers at Ohio State looked at the payment data of 33,542 consumers and found that when cardholders’ minimum payment requirements rose, many borrowers responded by sending bigger payments to their credit card companies — sometimes well beyond the smallest required payment.

But when researchers at the University of Chicago and the Consumer Financial Protection Bureau looked at cardholder payment data in 2014, they found that borrowers who owed at least $3,000 or more started paying less of their balances, on average, after their minimum payments increased. This was especially true of cardholders who previously paid their balances in full. For some reason, the small increases in minimum payments appears to have prompted some consumers to become balance revolvers, paying off only a portion of their cards.

Researchers aren’t sure why these cardholders acted so counter-intuitively. But they say it underscores that not everyone responds to well-intentioned nudges the same way, making it hard to come up with policies that are universally beneficial.

“A beneficial choice for one consumer may be detrimental for another, depending on what their choices would have been in the absence of the nudge” wrote University of Chicago professor Benjamin J. Keys and CFPB economist Jialan Wang in a 2014 policy brief. “These disparate impacts should be taken into account when weighing the overall welfare implications of any policy change.”

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