Sunday, April 15, 2007

Sunday dollars+cents: Unrealistically optimistic with credit cards

If “unrealistic optimism” leads Bridget Jones to pay far too much not to go to gym as I outlined here last Sunday, it may also be leading you and me to pay far too much not to pay off our credit cards.

I’ll explain.

The great mystery surrounding credit cards is why their interest rates remain so stubbornly high – around 17 per cent for cards from the major Australian banks – despite credit card fees and years of competition.

In the language economists use, credit card interest rates are “sticky downwards”...

It’s not just here. In the US the big banks charge card interest rates of up to 20 per cent, sometimes more. In Brazil they charge 50 per cent.

Dr Sha Yang of the New York University School of Business believes she knows why. She has just published her findings in a paper entitled Unrealistic Optimism in Consumer Credit Card Adoption. She says good many card users are wishful thinkers. Like Bridget Jones taking out a gym membership, they plan to do the right thing but can’t follow through.

To optimist who intends to always pay off his or her card on time, then the interest rate doesn’t matter. What does matter is the fee.

Using data from a survey conducted by a US credit card company she found that unrealistic optimists were indeed less likely to care about the interest rate (even though they ended up paying it) and likely to place far too much emphasis on getting a low fee.

In rough terms they cared about the interest rate only half as much as they should have, and paid twice as much attention to the fee.

For card providers, who make most of their money from the interest rate they charged when bills aren’t fully paid, these deluded customers are worth their weight in gold.

Dr Sha Yang then she used psychological tests to determine whether these sorts of customers were generally wishful thinkers (“hoping a miracle would happen” and so on). They were.

Our banks are on to this. That’s why they don’t much compete on credit card interest rates and why credit card interest rates don’t much move.

When a US bank released an "Elvis card" its response rate tripled. The National Australia Bank has done well out of an ipod-sized mini credit card.

The banks will offer us anything other than a mini credit card rate.

Until we wise up.

Yang, S., Markoczy, L. & Qi, M. (2007). Unrealistic optimism in consumer credit card adoption. Journal of Economic Psychology, 28, 170-185.

Dollars+cents,Sunday, April 08, 2007 Paying Not to go to the Gym

SMH, Wednesday, August 25, 2004 Credit Card interest rates: no competition