A recent study suggests that, in order to help people to better manage their debt, credit card companies should either increase the minimum repayment amount from the typical 2-3%, to 5%. This is part of an effort to help people pay off their debt more quickly and therefore more cheaply, than they are presently. You may feel that this is not particularly ground-breaking; raising the minimum payment will result in a shorter repayment period. However, the truly interesting area of study hinged on the principle that any minimum payment amount lowered our repayment expectations and in fact, removing the minimum would prompt borrowers to pay off more of their debt, rather than less.
Even though they might not be aware of it, people who pay off more than the minimum are also affected by these minimum payment values. A study conducted in the psychology department of Warwick University has shown that the smaller that minimum amount, the less people chose to pay over and above that. Shockingly, on average repayments rose by about 70% when a minimum payments amount was left off the credit card statement. This is due to a psychological phenomenon known as an anchoring effect. The minimum payment on a credit card statement acts as a psychological anchor, dragging down the amount they decide to repay. The majority of people do like the idea of paying a bit more than the minimum. It makes them feel like they are actually paying the debt off, rather than just the interest.
At the centre of this is an overall confusion surrounding compound interest. Simply put, interest is applied to the cost of your purchase in the first month, then in the second month you are charged interest on that interest as well as whatever you bought, then in the third month and so on and so on. The idea behind the minimum payment is that you pay off a bit of the interest and a bit of the original purchase price each month. The minimum is often so low that this has very little impact on the overall debt. So, even though you are making payments each month, payments greater than those outlined by your credit card company, your financial situation is not actually getting much better.
For debt help, talk to a debt advisor at Harrington Brooks, one of the longest established financial practices in the UK. They’ll be able to help you draw up a personal debt management plan that will help you to get out of debt as quickly as possible at a level you can afford. Use their debt wizard to assess your own level of debt and come to a conclusion on the best solution to suit your circumstances.