October 11, 2020

In the Red: Overdrafts, Payday Lending, and the Underbanked

By c05tkey

A novel approach to repaying debt could help consumers free themselves from crushing credit card balances faster, according to new research.

Rather than asking borrowers to make payments toward their total balances, Harvard Business School Professor Michael I. Norton and colleagues tested a method that lets consumers choose which purchases to pay off each month. Consumers who used this “repayment-by-purchase” method, on average, paid 12 percent more toward their balances.

With COVID-19 restrictions tamping down spending and New Year’s resolutions still on the brain, many borrowers are taking aim at their credit card debt, which totals $810 billion in the United States alone. As balances have climbed, the percent of household income allocated to repayment has decreased 17 percent over the last decade, and nearly 30 percent of consumers have reported failing to make a monthly payment, according to the Federal Reserve.

For people struggling to chip away at high balances, targeting specific items on their credit card bills can provide much-needed control and encouragement.

“Instead of a list of purchases that you can do nothing about, and you just feel bad, now you have a list of purchases, and you can decide which ones you want to get rid of,” says Norton, the Harold M. Brierley Professor of Business Administration at HBS, and a member of Harvard’s Behavioral Insights Group.

In their working paper,, Norton and his fellow researchers argue that separating the purchase from the actual payment demotivates consumers from paying more than the minimum. In contrast, repayment-by-purchase “recouples” the elements of the transaction and “brackets” the debt into smaller, more manageable chunks. It also provides a visual progress cue, as borrowers see purchases vanish from their statements.

Norton worked on the project with Grant E. Donnelly, an assistant professor at Ohio State University; Cait Lamberton, a marketing professor at the Wharton School of the University of Pennsylvania; Stephen Bush, senior manager at the Commonwealth Bank of Australia; and Zoë Chance, assistant professor of marketing at Yale School of Management.

Putting ‘repayment-by-purchase’ to the test

A field experiment conducted with the Commonwealth Bank of Australia, the nation’s largest bank, invited more than 136,000 customers to allocate their credit card payments across 14 spending categories using the company’s mobile app. About 1.5 percent, or 2,157 customers, opted into the feature, which let them pay down categories, such as “home,” “groceries,” and “transportation,” or eliminate them completely.

On average, customers who took advantage of the option to apply their payments to specific spending categories paid 12.18 percent more toward their debt than the control group, the research found.