Minimum Payments and Debt Paydown in Consumer Credit Cards

Ben Keys and Jialan Wang have a working paper called Minimum Payments and Credit Card Paydown. Most of my summary below are copy/pasted sentences from the paper.

Abstract

Using a dataset covering one quarter of the U.S. general-purpose credit card market, we document that 29% of accounts regularly make payments at or near the minimum payment. We exploit changes in issuers’ minimum payment formulas to distinguish between liquidity constraints and anchoring as explanations for the prevalence of near-minimum payments. At least 10% of all accounts respond more to the formula changes than expected based on liquidity constraints alone, representing a lower bound on the role of anchoring.

Using a back-of-envelope calculation, we estimate that anchoring consumers would save at least $570 million per year in interest charges if all issuers adopted the highest observed minimum payment formula in our sample.

Disclosures implemented by the CARD Act, an example of one potential policy solution to anchoring, resulted in fewer than 1% of accounts adopting an alternative suggested payment. Our results show that the design and salience of contract terms in credit products have significant impacts on household balance sheets.

Keys and Lang  position their paper as “the first empirical study to estimate the economic signicance of anchoring in the credit card market”; “Because the minimum payment is a lower bound on the optimal payment amount for the vast majority of consumers, anchoring would downwardly bias payment amounts and lead to suboptimally high debt levels, lower average consumption, and greater consumption volatility for affected consumers.”

They used the CFPB Credit Card Database (CCDB), that covered February 2008 to December 2013, and the issuers in the full dataset comprise over 85% of credit card industry balances. Based on a 1% random sample with about 40 million observations, they analysed three questions:

  1. Who pays the minimum? “We find that 29% of accounts pay exactly [9%] or close to (i.e. within $50 of) [20%] the minimum in most months. (…) Either many consumers are liquidity constrained at amounts that happen to be near the minimum, or that repayment decisions are in influenced by anchoring.”In the 1970s, typical minimum payments were about 5% of the outstanding balance. By the 2000s, the average minimum payment had fallen to 2%.

    Payment behavior is highly persistent over time both within and across accounts, it is only weakly correlated with traditional proxies for liquidity constraints.

  2. Minimal payments due to anchoring? “Taking advantage of the fact that several issuers changed their minimum payment formulas during the sample period. allows us to estimate the fraction of anchoring consumers by measuring before and after formula changes. using a dierence-in-dierences approach we nd that 9 to 20% of all accounts changed their payments by more than the mechanical effect alone.”At least 22% of accounts payed close to the minimum and at least 9% of all accounts anchor to the minimum payment. Estimated range is between 22% and 38%. Notably, the behavioral response is consistent, yielding a signicant fraction of anchoring consumers in response to both minimum payment increases and decreases. Consumers’ repayment choices are sensitive to changes in minimum payment formulas.
  3. Did the CARD-act nudge work? “”Nudges” that encourage higher payments; they measured the effect of one such disclosure required by the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009. The disclosure was mandated on more than half of all statements, and presents a calculation of the payment needed to amortize the outstanding balance in three years.” Figure 7 below shows what the disclosure looks like. “Fewer than 1% of accounts adopt the three-year repayment amount (…) a prominent policy change aimed at de-biasing consumers failed to yield a large economic effect relative to the influence of anchoring.”

fig7keysjang

We interpret the fraction of accounts that adopt the three-year repayment amount as an estimate of the ability for mandated disclosure to establish new anchors for consumer payments. The regulation specified that consumers who paid their balances in full for two months in a row and those whose minimum payments are higher than the three-year repayment amount are exempt from the disclosures.

Panel B of Figure 8 (see below) presents the difference-in-differences results around the implementation date. There are no pre-trends in the period prior to the implementation of the disclosure, in large part because very few consumers actively chose the three-year repayment amount in the absence of the disclosure.

keysJangFig8

In the five months following the CARD Act, we observe a sharp increase in the share of accounts paying the three-year disclosure amount. Although the economic impact is small, with treatment effects of less than 1%, the effect is statistically significant. Another trend visible in the figure is a deterioration of the effect of the disclosure over time. One reason for the decline in the disclosure’s effect could be habituation as consumers become accustomed to seeing the disclosure and “tune out” after its novelty wears off. We use this medium-run effect of 0.5% as the benchmark estimate of the disclosure’s overall impact.

Economic significance
Assuming that 0.5% of consumers who adopt the three-year payment amount would have otherwise made the minimum payment, we find that the disclosures led to an $0.18 per month increase in payments averaged across all accounts. We estimate that the disclosures saved consumers $62 million in interest charges in 2013.

If the disclosures had instead caused all anchoring consumers (estimated range between 22% and 38%) to move from the minimum payment to the three-year payment amount, we find that the interest savings in 2013 would have been two orders of magnitude larger, between $2.7 and $4.7 billion. The effect of the disclosures is substantially smaller than the economic role
of anchoring.

Conclusion
The modest effects we document of the CARD Act disclosures illustrate the challenges of changing real-world behavior using traditional forms of disclosure.

The answers to the 3 questions:

  1. Who pays the minimum? 29%
  2. Minimal payments due to anchoring? 22% – 38%
  3. Did the CARD-act nudge work? Yes, but very little (<1%)
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