From its origins as a metal plate in the Charga-Plate bookkeeping system to the digital versions available today, the credit card has gone through a fascinating evolution over time. Modern credit cards serve many purposes: They are not only a placeholder for making payments but they also offer benefits such as accumulating airline miles, securing loans, and receiving priority status for specific services. Recently, brands like Aspiration have begun offering carbon offsetting incentives to qualifying customers. However, although cardholders enjoy the benefits of payment management, they are also racking up starling amounts of credit card debt. revealed that U.S. credit card debts reached an alarming $930 billion, which surpasses the $870 billion peak during the 2008 recession (White 2022).

To help credit cardholders avoid debt accumulation, credit card companies offer a default option of making a minimum payment, whereby the cardholder pays a small fraction of the overall amount due every month instead of making the entire payment at once. However, a shows that the automatic minimum payment option can have the unintended consequence of causing the cardholder to accumulate more debt. The authors suggest that, by choosing automatic minimum payment as a default option, cardholders neglect to make larger payments, even if they had done so previously. This results in an overall increase in accumulated debt. Using detailed transaction data, the authors show that approximately 8% of all of the interest ever paid is due to this effect.

By choosing automatic minimum payment as a default option, cardholders neglect to make larger payments, even if they had done so previously. This results in an overall increase in accumulated debt…The authors show that approximately 8% of all of the interest ever paid is due to this effect.

Luckily, the authors find that if consumers are provided with a prompt to make payment in full or pay a larger amount, the negative psychological effects of automatic minimum payments are mitigated.

As this topic has important implications for consumers, marketers, and policymakers alike, we reached out to the authors with a few questions to gain a deeper understanding of the effect of default options on consumer behavior.

Q: How did you identify the need to research the effects of a default automatic minimum payment? What inspired you to start working on this interesting idea?

A: The work was initiated in response to the UK regulator’s credit card market study. Direct debits (or autopay in the U.S.) struck us as people self-selecting into a default, and we have a program of work to examine the long-term effects of defaults and other nudges. So, just because people avoid fees in the short term doesn’t mean that the overall objective—improved financial well-being—is a given. So, we look at the long-term effect on the level of all fees paid. Another example of this approach is discussed by Adams et al. (2018), where we find that nudging people away from automatic minimum repayment works well in that people switch to new repayments, but it ultimately appears to make no difference to financial well-being across the portfolio of cards they hold.

Q: How do you anticipate that paying off credit card debt in full rather than just the minimum payment defaults will affect people’s purchasing habits?

A: If people are roughly in a steady state, with consumption and debt static month to month, then they are just using the debt to live a few months ahead of their income. Paying credit card debt in full would need to be funded from increased debt, reduced consumption, or reduced savings. If people are co-holding savings and debt, this might make sense, provided they retain sufficient liquidity. If people can cut consumption for enough time to pay down the debt, this could also make sense, as the debt is not cheap. But for many, the debt is too large, and consumption is already pared back, so it would be very difficult. Collectively, credit card debt is very large and so paying it off all at once would likely have significant consequences for the economy.

Q: More than 60% of the sample in Study 1 used manual payments (p. 779). What motivates most consumers to use manual payments in your opinion? What role can marketers play in reducing apprehension about financial technology?

A: There are several issues here. Inertia may mean people never quite get around to setting up an automatic payment. People may also choose manual repayments to have greater control over their cash flow. Given the costs of going overdrawn on one’s current (checking) account, a large bill that might appear unexpected but is paid automatically is not desirable. Indeed, if credit cards are used to smooth over lumpy income or expenditure, automatically paying in full kind of defeats the point. Maybe people rightly fear financial technology. Often, it is not set up with consumers’ best interests as the primary objective. Strong regulation is important.

Q: Do you believe that providing rewards like cash back or discounts for full payments will have a more significant impact than the nudges looked at in the study?

A: Yes, it seems likely that stronger incentives to pay down credit card debt would be effective. But this raises the issue of who is paying for the cost of my credit card if I pay in full and get incentives for doing so. Yes, the card provider gets some money from the interchange fee charged by credit card companies to merchants, but this is not a huge amount. Given the slim margins, it seems unlikely the financial incentives could be that large.

Q: How do you think nudges from third parties like the “financial tips from Credit Karma” will mitigate the effect of anchoring on the minimum payment?

A: was inspired by our work on balance matching (Gathergood et al. 2019). I think there is room for third parties to help arbitrage a portfolio of finances. It is likely that removing the minimum payment option and allowing people to reflect and choose another amount will lead to fewer minimum repayments. But the U.S. Card act didn’t have much effect when repayment scenarios were introduced, which highlights the importance of randomized controlled trials ahead of, or along with, the introduction of a new policy, no matter how well meant.

Q: You mention in the paper that “default exists in many areas of individual choices.” How do you think financial companies misuse such defaults, and what is the possible win–win solution for both consumers and firms?

A: How many people have an autopay (“direct debit” in the UK) for something they do not need or want anymore? There is bound to be a fraction of automatic transactions that are no longer in consumers’ interests, even if they once were. So yes, I think there are lots of products that rely on people getting stuff wrong to make money and incorrectly forecasting what they will do. Indeed, was explicitly designed to take advantage of known weaknesses in behavioral economics to encourage people to save more in their pensions, and it worked. Though this had a positive intent, if used for evil, the same methods will work. For example, teaser rates have been commonplace for years in retail offers. The Financial Conduct Authority (the UK regulator) has launched a new UK consumer duty, where known behavioral biases are not to be exploited in designing new financial products. If these biases are used for good, as was intended with Save More Tomorrow, banks can help consumers achieve their goals, building a stronger relationship with their customers. But they have to be in it for the long term.

Read the full article:

Hiroaki Sakaguchi, Neil Stewart, John Gathergood, Paul Adams, Benedict Guttman-Kenney, Lucy Hayes, and Stefan Hunt (2022), “,” Journal of Marketing Research, 59 (4), 775–96. doi:

References:

White, A. (2022, December 20). Credit card debt in the U.S. hits all-time high of $930 billion-here’s how to tackle yours with a balance transfer. CNBC. Retrieved December 28, 2022, from https://www.cnbc.com/select/us-credit-card-debt-hits-all-time-high/

Adams, P., Guttman-Kenney, B., Hayes, L., Hunt, S., Laibson, D., & Stewart, N. (2018). The semblance of success in nudging consumers to pay down credit card debt. Financial Conduct Authority Occasional Paper, (45).

Gathergood, J., Mahoney, N., Stewart, N., & Weber, J. (2019). How do individuals repay their debt? the balance-matching heuristic. American Economic Review, (109), 844–875. https://doi.org/10.1257/aer.20180288

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Even pre-pandemic, many U.S. workers lived paycheck-to-paycheck and lacked the resources to overcome an unexpected financial setback. The COVID-19 pandemic has intensified the financial vulnerability of large swaths of consumers, bringing on historic unemployment levels, soaring food bank demand, and existential crises for small businesses.

When scholars and practitioners investigate financial vulnerability, they focus on those who lack sufficient personal income or wealth to acquire goods and services to meet everyday consumption needs. Such investigations create the impression that the defining characteristics of potential victims are absolute poverty or low income and wealth.

In a , we challenge the entrenched belief that financial vulnerability only affects low-income consumers. We find that most consumers across the socioeconomic spectrum may experience varying degrees of financial vulnerability at different points of their lives. Consumers can become financially vulnerable due to factors such as age (e.g., retirement), life events (e.g., divorce), economic cycles (e.g., inflation, recession), and unforeseen crises (e.g., natural disasters) that hinder access to financial resources in the short or long run. We think there is an urgent imperative to provide insights into this underexplored domain of consumer financial vulnerability (CFV) and to capture the reality of the large, heterogeneous population of financially vulnerable consumers.

Financial Vulnerability vs. Financial Harm

CFV represents the risk of experiencing future harm given a consumer’s current access to financial resources and expectations about (uncertain) future resource changes. This includes not only personal income and wealth but also extended financial resources from social relationships, government programs, and financial institutions. For example, young adults often rely on parents or grandparents when their income falls short. In contrast, older consumers rely on retirement savings and Social Security for income and Medicare for health insurance.

We emphasize that being financially vulnerable is not the same as having been harmed because of one’s financial circumstances. Many consumers are financially vulnerable at any given point in time, and some (but not all) of them may eventually experience harm.

One source of vulnerability is income volatility. For example, commission-based sales professionals, gig workers, and small business owners can have highly variable income, leaving them financially vulnerable due to risks posed by month-to-month income uncertainty. They may experience harm if their income dips too much in a certain month and they are unable to cover their living expenses.

On the other hand, consumers who have steady income but lack access to affordable health insurance are also financially vulnerable. Delaying preventive medical care can lead to a health crisis that results in physical harm, short-term disability, and an inability to return to work, with intensified, subsequent economic harms. This quicksand-like property of CFV and harm suggests that avoiding harm (e.g., health insurance) is often less costly than recovering from harm.

Short-Term vs. Long-Term Financial Costs

A full understanding of CFV often requires a broad time perspective. Consumer actions that appear ill-advised today may be beneficial in the long run and vice versa. For example, using a payday lender to repair the car that gets a consumer to work may appear to be a risky choice today, but this short-term cost may prove prudent in the long run if it means not missing work and losing income. On the other hand, new homeowners who purchase furniture using a retailer’s “no interest for 24 months” deferred interest financing offer benefit today from zero cost credit. But they could be vulnerable in the long run if they cannot repay the full amount within 24 months, incurring high retroactive interest costs. This latter example illustrates that having access to financial resources does not always decrease a consumer’s vulnerability.

We also emphasize that generalized financial literacy is not a panacea for reducing CFV and that financial knowledge varies widely among consumers. High-earning consumers who lose their jobs or face an extraordinary medical experience might have the know-how to decide between an emergency withdrawal from their 401K account versus taking on credit card debt, but they have little experience with government assistance programs, the medical insurance marketplace, or unemployment insurance. Financial knowledge is linked closely with one’s lived experience, and successfully navigating vulnerability inflection points during one’s lifetime often requires gaining new types of financial knowledge.

Finally, using data from a personal finance app, we illustrate how researchers and companies can estimate CFV; namely, the probability that accessible resources are insufficient for a consumer to avoid harm. Our approach to measuring CFV offers a foundation for scholars, practitioners, and policy makers to broaden their understanding and consideration of CFV and its effects on consumer well-being. It is time all stakeholders accept that CFV is not a unidimensional reflection of income but spans a nuanced, resource-based continuum along which consumers move dynamically.  

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From: Linda Court Salisbury, Gergana Y. Nenkov, Simon J. Blanchard, Ronald Paul Hill, Alexander L. Brown, and Kelly D. Martin, “,” Journal of Marketing.

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