For most Americans not able to pay off a credit-card balance, the most common choice at bill-paying time is to pay the minimum balance — an approach that keeps them treading water while the amount they owe increases.
We propose a different choice: Pay off specific purchases each month, such as a coffee from Starbucks, a pair of shoes or a gift for a friend, which then disappear from the bill. It may be a small amount, but it reduces the individual’s debt incrementally, in bite-size portions that they can actually afford.
Nearly half of all U.S. households report holding unsecured debt from credit cards; for 2017 the Board of Governors of the Federal Reserve put the national balance of revolving credit card debt at a little over $1 trillion. Repayment-by-purchase offers individuals a way to make progress toward reducing their debt instead of being paralyzed by the mass of what they owe.
We conducted a study with our colleagues Cait Lamberton at the University of Pittsburgh and Zoë Chance at the Yale School of Management, in which we gave cardholders a menu of payment options, including repayment-by-purchase. Those who maintain a revolving balance on their credit card each month and those who are delinquent in repaying their credit-card bills showed the largest response to our intervention. (Consumers who regularly pay their credit-card balance in full each month continued to do so.)
Consumers paid upward of 15% more toward their debt when allowed to scan their statement and target specific purchases for repayment. Why does this work? Because it reduces the feeling that a statement is an endless sea of debts. It leads consumers to feel as if they are making real progress toward reducing their debt with each purchase paid off.
It was also interesting to us that in choosing what purchases to pay for, people put essentials like groceries and utility bills before nonessentials like vacations, alcohol and dining out. This suggests to us that people feel more uncomfortable carrying a balance for basic living expenses than they do for extraordinary purchases. Previous research suggested that people would feel more inclined to pay off vacations because it’s hard to enjoy a vacation you haven’t paid for, whereas for durables like a washer-and-dryer combo it would feel all right to owe a debt because you enjoy the purchase over time. Our finding suggests that when picking among many items, people are drawn to the things they need vs. the things they wanted.
Repayment-by-purchase is a low-cost, practical intervention that changes consumers’ relationship to their debt. In fact, American Express now offers the ability to do just this through their online services: large purchases are flagged with a “Plan It” option, but smaller purchases are flagged with a “Pay It” option — allowing consumers to experience the kinds of small wins that our research suggests can help them reduce their debt.