Anchoring Minimums
Posted by Gail | Filed under Debt Traps
Everyone pretty well accepts the fact that credit card minimum payments are meant to keep you in debt for as long as possible so that credit card companies can make loads and loads of profit from interest charges. But did you know that by putting a minimum payment on your credit card bill, the credit card company is virtually guaranteeing that you’ll pay less?
Yup, once again, you’ve been had. Sure you knew they were screwing with your wallet, but you should be furious to find out they’re also screwing with your head.
Dr Neil Stewart, a psychology researcher at the University of Warwick in Coventry, England connected the phenomenon of “anchoring” to credit card payments. According to Dr. Stewart:
“In anchoring, arbitrary and irrelevant numbers bias people’s judgments and decisions, even when participants know that anchors are random or implausible.”
In other words, just because a number is there, even if that number has no meaning to us, it will affect our decision-making.
The good doctor found that the minimum payment amount stated on credit card statements acts as an anchor – think “new base level” — lowering the payments people make. These aren’t people who are paying only the minimum. These are people who are trying to get their debt paid off faster by paying more. That minimum payment box is like an anchor around their necks.
Two test groups were given credit card bills with $700 balances. The first group had no minimum payment amount listed. The second did. On average the first group paid $280 off, the equivalent of 40% of the balance. The second group paid an average of $161, or 23% of their balance.
Anchoring extends the length of time it takes for people to pay off their credit card debt because the lower the required minimum payment on the statement, the lower the actual payments, regardless of the borrower’s desire to get out of debt!
Dr. Stewart has been quoted in the media as saying:
“These results should be of real concern to credit card companies. Virtually all credit card statements include minimum payments. But this consumer safeguard has an unexpected negative consequence: Minimum payments distort the behaviour of many customers in a way that increases interest charges and increases the duration of their debt.”
M’thinks the doctor is either incredibly naïve or he’s got his tongue firmly in his cheek. Concerned indeed. No doubt the credit card companies have known for years just how effective their minimum payment strategy is in keeping borrowers on the hook. They know a whole lot more about us than we think.
An article in the New York Times provided a glimpse into just what our credit card companies know about us. For example, did you know that Canadian Tire cardholders who used their credit cards in drinking places missed four payments within the next 12 months? They do. And while the article focuses on the fact that today’s credit card companies are focusing on those customers most likely to honor their debts, no doubt any tactic that will keep customers on the hook longer and make ‘em more profitable will be an advantage.
Want to stop the credit card company from messin’ with your mind? Get yourself on a debt repayment plan of your own making and stick with it. The only thing the minimum payment amount is good for is to keep your account in good standing while you focus on paying off your most expensive debt first. If you’re using that minimum amount as a guide for how much to pay, even if you’re paying more than the minimum you’re a sucker.
November 18, 2009 at 7:46 am
hmm I think I’ve been anchored. When we paid off our debt we wanted to roll those payments into the payment of the last debt we have, however we haven’t do this because one thing or another have come up and we knew what the minimum was for that last debt, because it came out automatically from our account while we snowballed the other debts.
I think it’s time I brush off the anchor and make a renewed commitment to getting this debt paid off ASAP.
regards,
Jason
November 18, 2009 at 8:01 am
yes, the credit card companies want your money for as long as posible…BUT, if anyone actually took the time to read all the fine print in the agreement they would be alot further ahead…nobody wants to read the details they just want the money…even when I am going through a mortgage or loan committment with a client they are looking at their watches and zoning out…they just want to know where to sign so they can have the money….pitiful really…we must take responsibility for our messes..read the info and ask questions BEFORE you get into a position where you are in trouble…you can blame the lender all you want but the majority of blame should be on yourself!!!!
November 18, 2009 at 8:53 am
Years ago I worked as a Loans Officer that sold loans at 35% per annum. Clients always complained about the interest rate. Here’s the kicker though – the company didn’t charge anything whatsoever for extra or early payments, and didn’t put any limits on the pre-payments. For every loan that I closed, I showed the clients how much money they would save by paying an extra $20, $30 or $50 bucks on their loans. Paying extra payments meant lowering your principal, which lowered the interest you paid which lowered the effective interest rate on the loan. And you know what? Only 2 people ever paid extra. TWO! I agree with Gail – it is time that WE take charge of our financial situation and not allow some credit card company or financial institution do it for us.
November 18, 2009 at 9:02 am
Even if you pay your balance in full every month the CC company will still make a profit off you because every store where you use your CC pays a user fee to the CC company just so you could use your CC there.
You can set up an automatic payment from your bank accound to your CC for any amount you like, up to the full balance. This could put a new “minimum payment” in your head.
A credit card is a powerful tool if you use it properly. I’ve enjoyed the gift certificates I received and the special low interest rate offers which I’ve used to pay off higher interest rate debts faster. A teacher in high school told us the best thing we could do for our future borrowing needs was to get a credit card, use it and pay the balance every month.
November 18, 2009 at 10:23 am
In a day and age when you can get the credit card company to automatically deduct the payment, including *gasp* the full balance, from your chequing account every month, there should be no missed or late payments. Are there still that many paranoid Luddites in this world?
November 18, 2009 at 10:33 am
Wow. Imagine the $$$ that the CC invest in researching ways to screw with us! My sad confession of the day: I too have been a victim of the minimum payment psych-out. There have been times (not recently, Yay!) when I’ve been a little tight for cash, and “adjusted” my spending plan, telling myself that it was ok to lower my planned debt payment because I was still making the minimum payment.
Now that I’ve finally committed to getting that monkey off my back, I’ve realized that it’s not ok – and I actually find it fun to pay my bills (crazy?). I have a plan to be debt-free, and that’s how much the CC is getting, regardless of how little they are asking for this month.
November 18, 2009 at 10:42 am
Sparky is right, if people spent more time reading the fine details they would be further ahead. How many people get their statement, see the minimum payment due and just make the payment – good practice would be to look at your previous minimum payment and the amount that actually went to interest and compare that to the new balance. If the balance barely changed it means that your strategy needs to change as per recommendation, pay more than the minimum.
Spend within your means and pay off your credit card monthly and things such as interest rates will have no bearing on you, its time to get back to the days of responsible saving and spending.
November 18, 2009 at 10:46 am
Chubby Bunny you’re not crazy. I also get excited about paying my bills. Each dollar paid is one less dollar owed!
My car payment was at 9.9% and I paid it off with a CC cheque (my CC is 5.9%). The minimum balance on the CC was such that if I paid just the minimum I would have ADDED an extra 16 months to my pay off date despite the lower interest rate! Instead I’ve set a bare minimum payment that is $250 higher then my previous while I pay off some buy now pay laters (I know I know Gail, I’m sorry!!) Happily, the first one is paid off in two weeks (four months before the deadline) and the second one is paid off in June (5 months before the deadline) so I won’t have paid any interest! Once those two are gone I will snowball the payments onto my CC in the hopes of having it paid off by the end of 2010!
I just ignore the minimum payments that my CC requests!
November 18, 2009 at 10:56 am
Gail says “If you’re using that minimum amount as a guide for how much to pay, even if you’re paying more than the minimum you’re a sucker.”
…unless you pay the balance off in full… right??
November 18, 2009 at 11:01 am
Josee – The key is to pay off your credit card in full every month, so if you’re not doing that Gail is right, you’re a sucker. However, for those suckers out there that have spent more then they can afford, the next best thing is to try to pay more than the minimum balance outstanding so that more money is going towards principle versus interest.
November 18, 2009 at 11:15 am
wow – that’s really fascinating. Thanks for sharing this tidbit with us. I’ve never really bothered looking at the minimum payments b/c everything I do is online – so I just funneled as much as I could as often as I could to my CC until it was paid off.
I can see however; through my boyfriends decisions – how this anchor could cause some serious headaches.
November 18, 2009 at 11:29 am
It is amazing that when managing a credit card that users do not look at if they don’t pay the balance that new tv will cost $3000 instead of $1000.
November 18, 2009 at 1:15 pm
Another way the cc companies mess with your head is by upping your limit or not lowering it when you ask. I had a boyfriend who was terrible with money. He managed to consolidate his debts via a bank loan and while he was at the bank, asked the advisor to lower the limit on his cc. They never did. He never followed it up. As a result he racked up debt yet again. An endless vicious cycle.
November 18, 2009 at 1:23 pm
In the bad old days when I would open a credit card bill I would do my best NOT to look at the balance line – would skim right on down to the minimum payment line. Sometimes this alone was enough to make me hyperventilate.
I would always pay the minimum and a little more if I could. I never did the math and certainly never looked at the dollar value of interest we were being charged. The first time I really did this was when we were already in the swamp being nibbled at by the alligators. I remember that it not only shocked me but made me mad. How could I have been so stupid for so long? We were paying interest on the interest.
To keep the focus on how much interest really means in dollars I actually created a column on my budget spread sheet titled “Credit Interest” and I deposited money into and out of this. When you see the amount of interest going out each month it really, really gives you a smack upside the head. One month we paid over $800 in interest alone.
To start wading out of the swamp we started paying the minimum on each card plus the interest. As one card was paid off we increased the payment on the others but kept “paying” the interest separately. It was very motivating and satisfying to see the interest dollars decrease month after month. Made me feel like it was no longer their gotcha but ours.
November 18, 2009 at 1:26 pm
@ Chris – it wasn’t the lenders’ fault that your (ex) boyfriend racked up debt again. He did it on his own just fine.
I agree with the general commentary — people make their own decisions so stop making the lenders appear to the ones in the wrong. I like going to places and not having to carry cash and use a cc and be able to collect points and all other cute stuff, and yeah I sometimes think I should thank the people out there that pay just minimums or over limit service fees etc for helping make this possible. When else can I get a benefit that doesn’t cost me directly or indirectly?
November 18, 2009 at 1:44 pm
There is a minimum payment line on a credit card bill. Hmmm, I don’t think I have ever looked at it. CC are cash to me – if I don’t have the money I can’t use the card (ie. I always fully pay my balance each month).
I hate payng interest – working towards having the mortgage paid sooner rather than later – so more of my hard earned money stays as mine as versus the bank.
November 18, 2009 at 2:24 pm
I always look a the “interest” line at the top instead of the “minimum payment” line at the bottom.
Very educational!
Thankfully 99% of the time, the interest line says 0.00 thanks to my obsession with paying them off every month.
I see other people’s bills where they are paying $100/month OR MORE just in interest and I think about what fun they could have with that extra $100/month if they had just saved a bit before pulling out the plastic. I can’t afford an extra $100/month in expenses, I need that cash for long term savings, planned spending and my emergency fund!
It’s all about consequences for being impulsive. Truly some folks have terrible circumstances that put them behind the eightball in the first place, but most of us are just spoiled rotten with the convenience of the cards.
November 18, 2009 at 6:33 pm
This is a good opportunity to share the banking experience I had yesterday. It isn’t about CC, but rather, about my LOC.
I currently have a small sum of money on a LOC that I intend to have fully paid within the next 6 months. That said, the “financial advisor” I spoke with at the bank while setting up RESP’s for my children suggested I might consider changing my current “unsecured” LOC to a “secured” LOC. I asked what the benefit to me would be – get this: she said the bank would use my house as collateral to secure the LOC, thus allowing me to increase my LOC limit to 80% of the equity in my home, which would more than DOUBLE the credit I would have access to! The other benefit would be that the interest rate would be cut in half, but there would be an administration fee of $500 to make the changes. Hmmmm….. Okay, so if I understand her correctly, she WANTS me to borrow upwards of $50,000 on a LOC, and then, if I hit a financial snag and can’t make my payments, she’s repossess my house?!! Ummm, NO!!!
When I explained that I didn’t want to make any changes because I planned to pay off the credit line promptly and plan to no longer use it, she said something to the effect of “Well, a lot of people use credit lines to do home improvement projects or take a trip…. blah, blah, blah… You wouldn’t want to limit your opportunities, more blah, blah, blah…” …All I could hear was Gail’s voice telling her (and me) that she was trying to take advantage of me! I walked out of there disgusted that she calls herself a financial advisor and represents herself as someone who is helping me and my interests!!!
The sad part is that a lot of people fall for it… sad…
November 18, 2009 at 7:59 pm
As stated above we alone are responsible for our finances. We should be reading everything thoroughly before signing for credit or using our cards.
However, credit card companies don’t make it easy. Today I received an insert with my credit card statement. There will be changes made to the agreement as of Jan. 2010. The credit card company ONLY states the replacement language or phrases they will be deleting from the agreement. To get the full meaning of the changes one must go to and read the original agreement in our files (everyone has these right?) along with the insert. It takes effort to understand what’s happening with our credit terms – effort not many of us make.
They are also doing everything possible to have us focus on how much we can spend rather than on how much we have already spent and owe them. For example, I received my MBNA and HBC credit card statements today. Beside my name and account number at the top of my MBNA statement is my Credit Line amount and “Cash” or Credit Available amount. Since when do I have “Cash” on deposit with them? They make it sound as if they have cash for me and not a cash advance that accumulates interest from the get go. Their website is even worse. The first screen that pops up only shows Line of Credit and Available Credit amounts. You have to click into other screens to find out your outstanding balance.
HBC is even worse. Towards the top of the statement is bold letters is the Minimum Payment amount and Payment Due Date in bold letters. It is the first thing your eye is drawn to when you open the envelope. It isn’t until you look further down towards the bottom of the Account Details box that you see the Total Account Balance highlighted.
The banks and credit card companies have many ways of “guiding” us towards what they want us to focus on. It’s up to us not to scan our statements but to focus on exactly what’s happening. We have to actually think and look at ALL the information on the bills to know what things truly cost.
If your finances allow please don’t get into the hellish cycle of only paying the minimum. You’ll get tired of the “never ending” balance due and will start to believe that being in debt is normal.
November 18, 2009 at 8:20 pm
I may be a paranoid Luddite, but I can pay my bills on time….without relying on the computer.
Imagine!
November 18, 2009 at 9:24 pm
Alexandra, your comment about ‘cash’ available on a credit card is obviously something people take at face value. I work in a Casino, and the number of people who take cash advances on their credit cards makes my stomach hurt. They are feeding their addiction, and lining the pockets of the CC companies in one fell swoop. I, on the other hand, do not have a CC and at this moment wish I did. An uncle passed away, and I need to travel, knowing that the money is going to be there – next week. Doesn’t help me now, tho… and of course I am just getting into the saving for EF thing, but not there yet. Gonna get real aggressive ASAP tho, as soon as I get home.
November 18, 2009 at 10:08 pm
@Geoff – Sure thing it was absolutely my ex who spent the money, but the bank did him no favours.
November 18, 2009 at 11:06 pm
WOW. I actually heard about this, or a very similar, study in another context and did not apply it to credit cards. I’m going to do exactly what Gail says.
November 18, 2009 at 11:33 pm
This doesn’t really suprise me at all. I use CC as a tool. I always know how much has been charged to the CC and where the money is coming from to pay for every cent. I also always know within a few dollars how much is in my checking and savings accounts. I actually will pay my card off a couple of times a month. I can’t even remember the last time I received a statement showing a balance for my credit card. I actually thinks of my credit card as being linked to my checking account, it makes you think before you chard.
November 19, 2009 at 12:44 am
I too pay my credit card off bi-weekly. I use it as a tool to rebuild my credit as we had a bankrupcy after a job loss (and no work in our area)and were discharged 2 1/2 yrs ago. We moved out west from the maritimes and life has improved dramatically. There is well paying work and our credit score is rebuilding nicely, we have money in the bank, putting money into RRSP’s, a small mortgage and vehicles paid for in cash. I always say it really doesn’t matter to me what the interest rate is anymore as I have no intention of every letting it accumulate interest. We are doing fantastic now, pay cash, track our money and live a balanced life. What a welcome relief after years of struggling. I now live the Gail way and advocate it to everyone I know.
November 19, 2009 at 2:36 am
I’d really like to find a financial advice book (or write one! ) that explicitly talks about the idea of minimizing the amount of interest you pay over your lifetime (while still doing all the things you want to do, like buying a house, going to university, buying a car, etc.) It just seems to me that one component of ending up with a decent net worth over a lifetime, AND having a more fulfilling life, is to minimize interest payments–put that money instead partly towards savings and partly towards life experiences (or even “stuff”!) I think it would be an enlightening exercise for many to sit down and calculate how much money they have spent on interest over their lifetime–especially when they contrast it to how much they’ve got in their RSPs, RESPs, TFSAs, etc, or how many trips to Europe or other life goals those interest payments could have bought. Not all interest is avoidable (e.g. mortgage), but it can certainly be minimized.
November 19, 2009 at 8:28 am
I am pretty good with my money. I have a visa jar and put cash in there when I spend on my cc. I didnt realize that if not paid in full then had to pay interest on whole amoung!!
November 19, 2009 at 9:03 am
[...] What talk about Anchors you say? On Gail Vaz-Oxlade’s Blog yesterday she had a post about Anchoring Minimums. After reading that post I realized that with this last debt I’ve had the anchor shackled to [...]
November 19, 2009 at 9:29 am
@Diana – I don’t rely on my computer to pay my bills – they (credit card balances included) are paid in full the day they arrive – I recently moved and was checking websites to confirm that my change of address had been updated properly so that I wouldn’t miss a bill
@ Suzanne – I see it at the Casinos too – once or twice a year (depending on how I take my vacation time) I like to take a couple of hundred dollars out of my “fun money” account to play Poker. My stomach also hurts when I see people take cash advances and also use the Casino’s ATMs. I like to “people watch”. Some of them look like lost souls when they leave.
November 19, 2009 at 10:17 am
@ Diana – Yeah, I managed to pay all my bills on time too using the traditional methods. Imagine! But there was a better option available for me, someone who prefers to spend time making money instead of making bill payments, and I took it.
And imagine this: my statement applies to those who are making late payments (and, thus, not you). I’m saying they shouldn’t because there is a solution for their problem. Why aren’t they applying this solution?
November 19, 2009 at 10:30 am
Aha! I knew there was a reason I only looked at the amount I owe the CC company and not the minimum they want back from me each month!
I may be in credit card debt, but i’ve been on my own repayment plan for a while now – making decent payments back to the company each month. I’m not in a position of being able to pay it off each month yet but I am definitely taking firm, regular strides towards that goal. Not as big a fool as I thought I was for paying more than minimum.
November 20, 2009 at 12:38 am
“Mrs T. says:…financial advisor” I spoke with at the bank suggested I might consider changing my current “unsecured” LOC to a “secured” LOC. When I explained that I didn’t want to make any changes because I planned to pay off the credit line promptly and plan to no longer use it, she said something to the effect of “Well, a lot of people use credit lines to do home improvement projects or take a trip…. blah, blah, blah.”
I had virtually the same conversation when I was seeing what was the best rate my bank could give me on my LOC! Needless to say I opted to stay with an unsecured LOC.
I don’t even know where the minimum payment box is on my credit card statement nor what the current rate of interest is. I ALWAYS pay it off in full each month so the total owed box is all I care about.
I do know that credit card companies are always trying to up my credit limit and I phone them and tell them to put it back to where it was. If I did have a major purchase I couldn’t pay for with cash, why would I be stupid enough to put it on a credit card which has interest rates of 20% (or whatever the going rate is) when I have a LOC at 6.75%? They always seem a bit surprised when I tell them that, which makes me wonder how many people fall into their traps. From watching TDDUP I’m afraid far too many people do.
November 20, 2009 at 7:51 am
When i was a student, i got a student credit card. never having used them before i was pretty nervous about it and used it only in emergencies. after about 3 years i had my computer basically die. I had been saving up and had the money to pay for it, i just had to go and pick it out. well i ended up needing to buy it online with my credit card.
so i have a $700 limit that’s been with me on that card for 3-4 years with a good repayment history(I paid in full ever since i got it). I call the credit card company and ask to have my limit raised so that i can make this purchase. Their one and only important question was how much did i make per year. As a student, only working summers, i made abotu $5000 a year. Now what would you think they would give me for a credit limit(i never asked for a amount)? 1500, 2000………..no a $3700 new limit! they were just waiting for me to over do it and end up paying hundreds of dollars in interest.
After finishing school i started work and wanted to open a line of credit for emergencies (since i was broke coming out of school and wanted better interest than what was on my CC) they looked at my good credit rating and asked me how much i wanted. on a unsecured LOC from a student just finished school they didn’t even blink when i asked for a random number like $10000. so far i’ve only ever used it one and that was for 5 days while i waited for a cheque i knew was going to arrive.
I’ve been pretty good with my credit but it would have been very easy to end up like some of the people on gail’s show. and after my small experience geez, i wonder how we came into a recesion….TOO MUCH CREDIT!
November 22, 2009 at 1:07 pm
I noticed when I lived in the States that there also must be laws about font sizes. My US Visa had the minimum payment in a huge font. I had to hunt around on the bill to figure out what I actually owed. If I had poor literacy, or poor vision, I would probably pay the minimum simply because I couldn’t read what my balance was. Not true of my Canadian visa, where both numbers are clear.
November 24, 2009 at 4:02 pm
wow, it pretty interesting. i just finish reading the actual article as well and i realized Stewart’s research leaves many questions unanswered. If you received grant money to follow up this work, what research question would be of interest to you?
I just think there are more detailed needed to this follow-up report from neil stewart =)