When Setting a Default Payment Harms Credit Card Holders

43 Pages Posted: 4 Aug 2018

See all articles by Hiroaki Sakaguchi

Hiroaki Sakaguchi

University of Warwick

Neil Stewart

Warwick Business School, University of Warwick

John Gathergood

University of Nottingham - School of Economics

Date Written: July 27, 2018

Abstract

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.

Keywords: Defaults; Inattention; Prominence; Automatic Repayment; Credit Card

JEL Classification: D10

Suggested Citation

Sakaguchi, Hiroaki and Stewart, Neil and Gathergood, John, When Setting a Default Payment Harms Credit Card Holders (July 27, 2018). Available at SSRN: https://ssrn.com/abstract=3221299 or http://dx.doi.org/10.2139/ssrn.3221299

Hiroaki Sakaguchi

University of Warwick ( email )

Gibbet Hill Rd.
Coventry, West Midlands CV4 8UW
United Kingdom

Neil Stewart (Contact Author)

Warwick Business School, University of Warwick ( email )

Gibbet Hill Road
Coventry, West Midlands CV4 8UW
United Kingdom

HOME PAGE: http://www.stewart.warwick.ac.uk

John Gathergood

University of Nottingham - School of Economics ( email )

Sir Clive Granger Building
University Park
Nottingham, NG7 2RD
United Kingdom

HOME PAGE: http://https://sites.google.com/site/gathergoodjohn/

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