Non-Technical Summary:
Growing credit card debt can be a source of substantial financial difficulty for some borrowers and their families. For many, the growth of credit card debt may stem from the choice to make only the lowest possible repayment that satisfies their credit agreement each month: the minimum repayment. One reason borrowers may pay the minimum amount is that they simply do not have the ability to repay more. However, borrowers may also be motivated by behavioural factors such as acting over-optimistically, ‘anchoring’ on the minimum repayment or not fully understanding the implications for future debt accumulation when paying the minimum. This paper investigates the capacity of a financial tool called Prize Linked Debt (PLD) to increase debt repayments amongst those who make the minimum repayment but are not constrained to doing so, using an online experiment with 858 participants.
PLD entails a prize threshold set above the credit card minimum repayment threshold. A borrower can become eligible to win a prize with lottery-like odds by repaying on or above the prize threshold. PLD is tested in this paper by offering participants in an online experiment a series of financially incentivized decisions. All participants make a set of three decisions which are the same between participants. In a second set of decisions otherwise identical to the first, some participants are offered the PLD and some are not. A prize threshold set on average 37% above the minimum increases repayments by 31% for those offered PLD compared to those who are not, amongst participants who repaid the minimum before being offered PLD. The probability of repaying the minimum falls by 69.1% for this population.
Examining the PLD further, three aspects make up the effect: financial advice to pay more than the minimum, the suggestion of a specific amount to repay (‘anchoring’) and the ‘skewness’ of the financial incentive (e.g. the difference between a 5% chance of winning $400 compared to a 50% chance of winning $40 compared to a guaranteed $20). All of these characteristics are tested in the experiment by offering some participants a promotion which replicates one of the above aspects of the PLD and comparing repayments between this group and the group of people who were offered the full PLD. The advice effect makes up roughly half of the PLD effect, while anchoring does not contribute much more than this. Evidence for the effects of skewness are inconclusive.
Some credit card issuers have explored tools to proactively increase repayments amongst borrowers who have problematic debt. These tools (for example, sending reminders to borrowers when payments are due) aim to help borrowers who pay the minimum not because they cannot pay more, but for behavioural reasons. PLD provides an additional tool that policy-makers or financial institutions can use to increase repayments amongst borrowers who consistently make low repayments. PLD would be preferable to, for example, raising the minimum, as no cost is imposed on those who are unable to increase their repayments. Implementations of PLD should seek to diminish the possibility of borrowers trying to ‘game’ their way into the program by making low repayments.