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When Setting a Default Payment Harms Credit Card Holders - SRRN Working Paper published online July 2018

Automatic payments are increasingly common. The psychologies of the prominent of number, defaults and inattention combine to create an unexpected side effect of automatic payments. We see that credit card holders set a default automatic payment to match their modal repayment behavior. For those often paying in full, an automatic full repayment almost completely eliminates late fees caused when people forget to pay their bill. For those often paying only the minimum, an automatic minimum repayment locks in their modal minimum payment behavior. But it was their amodal behavior—occasionally making larger repayments at prominent amounts
(e.g., £100, £200, £500)—that was reducing their balance. Without the need to address their bill each month, card holders make these additional repayments less often, and as a result incur 2–3 times more in interest charges than the late-payment fees that they avoid by automating their payments. We estimate that the reduction in prominent amount repayments as people switch to automatic minimum repayment is responsible for 12% of all of the interest ever paid on credit cards.

Authors:  Hiroaki Sakaguchi, Neil Stewart and John Gathergood

 

 

Posted on Wednesday 19th December 2018

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