Policy Spotlight: Higher minimum credit card payments could help reduce indebtedness

“…it is time for our financial system to change minimum payment amounts. The link between low minimums and prolonged indebtedness — and compromised financial health — is quite clear.”

Credit card holders in the U.S. typically must pay one percent of the principal balance plus interest and fees to stay current on their accounts. “Mandating higher minimum payment amounts could help overcome common behavioral and cognitive biases that prolong indebtedness,” say the Financial Health Network’s Jennifer Tescher and Corey Stone in a new report from The Brookings Institution.

Half of U.S. households “revolved” credit card debt (i.e. carried a balance) in 2021. They paid $111 billion-ish in fees and interest. “Heavy revolvers,” who carried balances in more than half of the 18 months beginning in January of 2019, accounted for 40 percent of outstanding balances and paid 85 percent of finance charges. A minority of account holders pay the majority of the revolving costs.

Credit revolvers tend to carry debt for months. And months. Meanwhile, their ability to save and available credit lines are diminished or destroyed. For many, “excessive card debt leads to delinquency or default, leaving them unable to access less expensive forms of long-term credit.” Many are our clients, feeling trapped in a seemingly inescapable cycle of debt that increases their stress levels and hampers their productivity and mental health.

The authors urge the federal prudential bank regulators — including the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency — and the Consumer Financial Protection Bureau to ensure that “consumers select a minimum payment formula based on the time and cost it would take them to pay down the account at full utilization and with the current minimum set as a floor.”

Such an approach could help overcome three behavioral biases that scientists say can contribute to lasting indebtedness: anchoring, over-optimism, and the endowment effect.

Borrowers tend to “anchor” to the minimum payment amount. Three in 10-ish of all credit card accounts, and about half of all card revolvers, “make monthly debt repayments regularly at or near the minimum payment amount.” Part of this phenomenon is due to the fact that most people don’t understand how long it will take to pay off debt or how much it will cost. In one U.K. survey, 94 percent of respondents “estimated a shorter period than the correct answer (18 years and 9 months), and 59 percent were wildly off, estimating pay-off within 5 years, with 34 percent estimating they would be debt free within 3 years.”

Over-optimism brings together unrealistic timelines for paying down debt with the double whammy of “selecting cards with higher interest rates” because they have attractive rewards, and of not expecting to carry a balance. Many of us can relate.

The endowment effect (people with cash on hand for emergencies tend to be reluctant to part with it, unless they have A Lot of it) holds true “even when faster paydowns would save them money that could replenish their savings and free up credit that they could tap should emergencies arise.”

Together, these biases, and a jobs and benefits system that fails to offer a majority of employees a viable path to financial security, make it hard for millions of people, from employees to gig workers, to escape debt — which is bad for workers and for business.

As Tescher and Stone conclude: “With interest rates on the rise, large card issuers robustly profitable, and card delinquency and charge-off rates at historic lows…it is time for our financial system to change minimum payment amounts. The link between low minimums and prolonged indebtedness — and compromised financial health — is quite clear.”