Another way that credit cards dupe the brain into spending way too much money on interest payments:
New research by the University of Warwick reveals that many credit card customers become fixated on the level of minimum payments given on credit card bills. The mere presence of a minimum payment is enough to reduce the actual amount many people choose to pay on their bills, leading to further interest payments.
The research, by University of Warwick Psychology researcher Dr Neil Stewart, is to be published in Psychological Science, in a paper entitled “The Cost of Anchoring on Credit Card Minimum Payments”. It focuses on the psychological phenomenon of “anchoring” in which arbitrary and irrelevant numbers bias people’s judgments.
The research reveals that anchoring affects the way people repay their credit card bills. For those people who make only partial repayments of the outstanding balance (about 35% of card holders), the suggested minimum payment on the credit card statement acts as an anchor and lowers the actual repayments people choose to make.
A few years ago, a group of MIT economists decided to conduct an auction with their business graduate students. (The experiment was later conducted on executives and managers at the MIT Executive Education Program with similar results.) The researchers were selling a motley group of items, from a fancy bottle of French wine to a cordless keyboard to a box of chocolate truffles. The auction, however, came with a twist: before the students could bid, they were asked to write down the last two digits of their social security number. Then, they were supposed to say whether or not they would be willing to pay that numerical amount for each of the products. For instance, if the last two digits of their social security number were 55, then they’d have to decide whether or not the bottle of wine or the cordless keyboard were worth $55. Finally, the students were instructed to write down the maximum amount they were willing to pay for the various items.
If people were perfectly rational agents, then writing down their social security numbers should have no effect on their auction bids. In other words, a student with a low valued social security number (like 10) should be willing to pay roughly the same price as someone with a high valued number (like 90). But that’s not what happened. Look, for instance, at the bidding for the cordless keyboard. Students with the highest social security numbers (80-99) made an average bid of $56. In contrast, the average bid made by students with the lowest numbers (1-20) was a paltry $16. A similar trend held for every single item. On average, students with higher numbers were willing to spend 300 percent more than those with low numbers. All of the business students realized, of course, that the last two digits of their social security number were completely irrelevant. Such a thing shouldn’t influence their bid. And yet, it clearly did.
This is known as the anchoring effect, since a meaningless anchor⎯in this case, a random number⎯can strongly impact our subsequent decisions. The same thing happens when people see the minimum payment on a credit card bill, which distorts the payment they end up making. While it’s easy to mock the irrational bids of the business students, the anchoring effect is actually a common consumer mistake. Consider the price tags in a car dealership. Nobody actually pays the prices listed in bold black ink on the windows. Rather, the inflated sticker is merely an anchor that allows the car salesman to make the real price of the car seem like a better deal. When we are offered the inevitable discount, the brain is convinced that the car is a bargain.
In essence, the anchoring effect is about the brain’s spectacular inability to dismiss irrelevant information. Car shoppers should ignore the manufacturer’s suggested retail price, just as MIT grad students should ignore their social security number. The problem is that the rational brain isn’t good at disregarding facts, even when it knows those facts are useless. And so, if we’re looking at a car, the sticker price serves as a point of comparison, even though it’s merely a gimmick. And when we’re making a bid on a cordless keyboard, we can’t help but tender an offer that takes our social security number into account, simply because that number has already been placed into the pertinent decision-making ledger. The random digits are stuck in the conscious brain, occupying valuable cognitive space. As a result, they become a starting point when we think about how much we’re willing to pay for a computer accessory or how big a check we’re willing to write to the credit card company.
Thanks for the tip, Kevin!