Credit card minimum repayments the hidden danger in your post-Christmas bill
Economists have found the minimum payments that appear on monthly credit card statements act as an "anchor" causing many consumers to pay off less debt than they otherwise would – and should.
A study by American researchers Benjamin Keys and Jialan Wang shows that almost a third of card borrowers in the US make payments at or near the monthly minimum. Their findings suggest a substantial proportion of consumers – up to one in five – settle for the lowest possible payment even though they could afford to pay more.
Incongruous sentence above. It cant be a third being 33% in the US make payments at or near the monthly minimum and then 20% that settle for the lowest possible payment. Is it 33% or 20% that only pay the 2½% minimum?
"A large fraction of near-minimum payers appear to treat the minimum as an anchor," the study published by America's National Bureau of Economic Research said.
That means higher balances, higher interest costs and eventually greater financial risk for many card holders. At the national level the influence of the minimum payments may be helping to elevate household debt, which makes the whole economy more vulnerable to shocks.
Australian credit card users are also susceptible. A consultation paper released this year by the Australian Treasury said "a growing body of experimental research and field studies have shown that some consumers make a smaller repayment than they otherwise would have simply due to the presence of the minimum repayment."
The Treasury paper said card issuing companies set minimum repayment amounts as a very small proportion of the outstanding balance, "so that households making the minimum repayment will only pay off their balance over a very long period and incur very large interest costs."
Gerard Brody, chief executive of Consumer Action Law Centre, said that credit card users should focus on the total amount outstanding on their credit card statement and pay off as much as possible rather than the minimum payment.
"The minimum payment might look easy to pay but that's all the bank wants you to pay," he said.
"They know that if you do that, they will make a lot of money from you in interest payments. What you should be focused on is the full amount outstanding and paying that before the due date when the interest payments come through."
There are no regulations that determine how credit card minimum payments are set. The Treasury's paper said they are typically 2-3 per cent of the outstanding balance.
Consumer advocacy groups including the Consumer Action Law Centre and CHOICE say minimum repayments should be lifted to ensure consumers aren't lumbered with high interest debt for decades.
CHOICE spokeswoman Nicky Breen said card issuers should also be required to "proactively contact customers" who are only making minimum payments and drawing out their debt.
"The federal government has had a consultation on broad credit card reform but no decisions have been made as of yet," she said.
Some card users simply don't have enough money to repay any more than the minimum. But Dr Keys and Dr Wang observe that when American credit card companies lifted their minimum payments, consumers paid the higher amount most of the time, suggesting they could have contributed that much all along.
Bessie Hassan, from financial comparison website finder.com.au, said card users with the means to make payments above the minimum payment should make a conscious effort to do so.
"Many borrowers fall into the mentality of thinking they just need to make the minimum payment on their credit card, or some may simply be unaware that they can make overpayments," she said.
"Typically, there's no cost involved for making overpayments so you've got nothing to lose and everything to gain."
Ms Hassan said that if a consumer with an average credit card debt of $3073 (and average card purchase interest rate of 17.31 per cent) paid the minimum repayment of $62, it would take 24 years to settle the debt and a total of $6000 in interest would be paid.
"However, if you increased your minimum monthly repayments by $50 to $112…you'd pay it off within three years and only pay a total of $867 in interest," she said.
Since 2011 Australian card issuers have been required to tell customers on statements how long it will take to repay debt if only the minimum payment is made.
But Mr Brody said there has not yet been any "rigorous analysis" of what impact this requirement has had on the behaviour of credit card users.