Monday, 8 June 2009

Psychological bias=more credit card interest

Financial rules in the U.K. mean that credit card companies have to take a minimum payment from card-holders each month. It's meant to keep card-holders from getting into too much debt. 

Yet there's a psychological decision-making bias known as "anchoring" that operates against this. 

The compulsory minimum payment leads many card-holders to pay less off their balance than they would have done, thus costing them more in the long-run.

Researchers from Warwick University conducted a survey of 248 credit-card users and their statements and found those card-holders (36 per cent) who paid more than the minimum payment but less than the total balance, were influenced by the size of the minimum payment. The lower the minimum amount, the less they paid. It's as if knowledge of the minimum payment reduced how much they chose to pay off. 

In a further experiment hundreds of participants were given a credit-card bill with an outstanding balance of £435.76 and asked how much they could afford to pay off, given their real-life finances. Half saw a minimum repayment amount and half didn't.

Seeing a minimum payment amount didn't affect the proportion of participants who said they'd pay the balance off in full. However, of those who said they'd pay only some of the bill, the minimum payment amount had a dramatic effect on how much they said they'd pay. In real life the difference could double the ultimate amount of interest paid by the card-holder over the life of the debt.

Anchoring was first shown by Kahneman and Amos Tversky in 1974. They asked people to spin a random number wheel before estimating what proportion of United Nations countries were African. People's guesses were strongly influenced by whether the wheel landed on a high or low number, even though they knew the number had nothing to do with the question!

The researcher Neil Stewart has set up a website that helps you calculate what the total costs of a loan will be given how quickly you choose to pay off your debt.


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