McDonough School of Business
News Story

Fed Hikes Interest Rates: How to Expedite Paying off Credit Card Debt

This month’s Federal Reserve interest rate hike will cost consumers $1.6 billion in credit card interest, according to WalletHub, which also recently reported credit card debt is expected to top $1 trillion in 2017. This all comes at a time when consumers are receiving their tax refunds in the mail and contemplating how to spend them. While splurging on a fun getaway or the latest technology gadget is tempting, given predictions that interest rates are to continue to escalate this year, it is time to consider tackling burdensome credit card debt.

“Repayment Concentration and Consumer Motivation to Get Out of Debt,” which published in the Journal of Consumer Research, explores the psychology behind how consumers choose to allocate their money between multiple credit card balances and provides insights into how to get out of debt. The study is co-authored by Simon Blanchard, assistant professor of marketing at Georgetown University’s McDonough School of Business; Remi Trudel, assistant professor of marketing at Boston University; Keri Kettle, assistant professor of marketing at the University of Manitoba; and Gerald Häubl, professor of marketing at the University of Alberta.

For consumers with multiple credit cards and similar interest rates, the research finds paying the smallest debt first allows card holders to see progress quickly, which can better motivate them to continue chipping away at debt.

“First and foremost, try to pay the minimum across all your card debts to avoid late fees that hurt your credit,” Blanchard said. “Assuming interest rates between cards are similar, with remaining funds available, our research shows that making a large repayment on a small debt, even if it is not possible to pay off the balance in full, can greatly motivate consumers. The extra motivation can carry over, and lead consumers to engage in smart financial behaviors like picking up an extra shift at work, saving more, and even spending less.”

Several experiments were conducted as part of the study, one of which included an evaluation of anonymous monthly credit card data obtained from HelloWallet. Spanning 36 months for nearly 6,000 clients, the research found when consumers concentrated repayments, in the following month, they made greater repayments than when they had dispersed repayments equally across multiple accounts.

“Just as interest compounds, so does motivation,” Blanchard said. “When consumers concentrated their repayments on a small account, they could more easily see progress through the big chunk of debt removed from one account. Even when consumers are far from achieving an account balance of zero, the mere feeling of progress can be impactful.”
In fact, one experiment showed this repayment concentration, which focused on one debt at a time, resulted in debts being repaid 15 percent faster. The study also found that when most of the debt is consolidated into just a couple accounts, making repayments to those large accounts can be de-motivating, as consumers feel little progress when just a small percentage of their debt is reduced.

“Psychology plays a significant role in successfully tackling credit card debt,” Blanchard said. “When small victories such as closing an account are rare, seeing progress becomes a lot less about looking at the finish line and a lot more about the distance made every time. Applying that tax refund toward a concentrated repayment strategy can help consumers become debt-free sooner than they think,” Blanchard said.