Executive Summary

Credit cards are a popular payment instrument that allows individuals to purchase goods and services when they do not have cash available. If misused, credit cards can lead to indebtedness and consequences to financial and overall wellbeing, as reported in literature.

In Brazil, credit cards are the most frequent type of household debt, reported by more than 70% of indebted families on a national survey. Two unique characteristics of the Brazilian market help explain the high indebtedness levels: average interest rates of 300% annually, and instalment plans adopted in 55% of all credit card transactions.

This report maps four behavioural issues, as indicated in blue in the model below, that represents a journey to credit card misuse and indebtedness on an individual level:

Framing of credit card limit as available money due to credit limit misconception, associated with limited self-control and a change in reference point that comes with instalment plans contribute to potentially increase consumption that is not accompanied by income increase. Adding to this, anchoring on minimum payment maximises the negative effect of high interest rates, making the full repayment of credit card balance more challenging.

To address those behavioural issues aiming to reduce credit card misuse and indebtedness, we suggest behaviourally-informed interventions that a) help consumers to deal with self-control problems and connect the “spender” past self with the “payer” present self; b) frame credit limit as borrowed money; c) help people keep track of cumulative instalments; and d) develop a new choice architecture for minimum payment.

However, there is a need for further research to explore evidence gaps. Two examples are related to the mental accounting of paying with credit cards as opposed to other methods, and the level of understanding individuals have on negative impacts of minimum payments. Relevant ethical concerns related to the suggested interventions are also discussed, namely the fairness of inputting negative incentives in the form of costs on credit card payments, and an individual’s right to spend and default according to her preferences.

1. Credit Card Misuse and Indebtedness

1.1. Defining the Problem

Credit cards are payment instruments that have two main functions: substitute cash and provide liquidity if one does not have enough cash equivalents (Thaler & Sunstein, 2021). Therefore, credit cards essentially differ from other payment methods by allowing individuals to get the benefits of a product or service with no instant account withdrawal. Consumers have a set period of time between 20 and 55 days during which no interest is charged (Citizens Advice, 2022). After that, if a consumer does not pay the full credit card balance on time, they are charged interests. Credit card users are set a credit limit, the total authorised amount for spending before repayments, provided by the issuer of the credit card.

Credit card misuse emerges when one lacks the funds to pay for the full credit card balance and therefore is at risk of being charged interest rates for revolving credit that increase the debt even further. Issuers typically set minimum payments that allow users to continue using the card while financing revolving credit.

Credit card debt is a debilitating type of financial crisis consumers experience (Smith et al., 2015). In this report, we consider indebted consumers who do not pay off the total amount of the credit card balance when payment is due. Indebtedness has implications for wellbeing and health. Individuals in debt have reported lower levels of psychological wellbeing compared to those with no outstanding credit (Brown et al., 2005) and poorer subjective health and health-related behaviour (Turunen & Hiilamo, 2014).

1.2. Context in Brazil

Credit cards are a popular payment method in Brazil, where they are almost as often used as debit cards are. While the first instrument is used in 19.58% of all financial transactions, the latter accounts for 21.44% (Banco Central do Brasil, 2022). As of 2020, there were 134 million active credit cards registered at the country’s Central Bank (Nascimento, 2021). Brazil’s employed population currently sums 92.7 million people (Lameiras et al., 2021). Therefore, the average credit card number per employed person is 1.4. Taking into consideration estimates that suggest that 48.7% of employed people are informal workers (Gombata, 2021), the number of active credit cards is surprisingly high. So is credit card indebtedness.

Credit cards are the most frequent type of debt among Brazilian households, reported by more than 70% of indebted families on a national survey (Bertran & Echeverry, 2021). Brazil is indeed one of the countries with the highest default rates in credit cards (Sousa et al., 2016). Two particular characteristics of the credit card market in Brazil might help explain why indebtedness is widespread: on one hand, outrageously high interest rates for revolving credit of around 300% annually, as compared to around 3% in the United States and Europe; on the other hand, there is a widespread practice of paying for purchases in multiple instalments, what is reported to happen in 55% of all credit card transactions (Bertran & Echeverry, 2021; Peduzzi, 2021).

2. Behavioural Issues

2.1. A Model for Comprehending Credit Card Indebtedness on an Individual Level

We developed the model on Figure 1 to support the investigation of when and how behavioural issues arise on credit card use. We assume an individual is endowed a credit card with a credit limit in t0. The limit is erroneously judged as available money to spend (Abrantes-Braga & Veludo-de-Oliveira, 2020), although income remains constant. If the person develops a consistent preference for paying in instalments in t1, which is rather common in Brazil, and it leads to an increase in consumption through a change in reference point as we are going to explore later, cumulative instalments summing up make it more difficult to pay off credit card balance in t2. The result of credit card misuse is being charged high interest rates to finance the monthly balance that remained unpaid. High interest rates make the debt even more difficult to pay, resulting eventually in indebtedness.

2.2. A Chain of Behavioural Issues Leading to Indebtedness

Credit card is a financial product that inherently evokes intertemporal decision-making. A reward (purchase) is obtained in the present moment while payment is due in a future moment. In addition to this, peculiar characteristics of the product as a payment instrument can lead to quick, intuitive, System 1 thinking, resulting in systematic errors (Kahneman, 2011) that eventually can lead to indebtedness.

Next in this report, we develop four behavioural issues. Although together they can have a relevant influence in causing indebtedness, there is no intention in stating them as an exhaustive list of behavioural issues.

2.2.1. Limited Self-Control and Dissociation between Past and Present Selves

Although standard economics often assumes that individuals’ preferences cannot change over time, people tend to demonstrate self-control problems, which are largely studied in psychology research (O’Donoghue & Rabin, 2003). Models such as the hyperbolic-discounting model aim to capture preferences in intertemporal choices. As explained by Frederick et al., “hyperbolic-discounting models predict that people respond especially strongly to immediate costs and benefits, and visceral influences have powerful transient effects on immediate utilities” (2002, p. 377).

Credit cards can potentially amplify impulsive choices and self-control problems predicted by hyperbolic-discounting models as benefits and costs are separated in time, being the benefit immediate and the cost delayed. “Self-control problems occur when the benefits of consumption occur earlier and are dissociated from the costs, and this is typically the case of revolving consumer credit products” (Anderloni & Vandone, 2011, p. 80). Overspending can be higher when individuals feel that they are expected to consume as much as people they care about, in shared experiences (Sotiropoulos & D’astous, 2012).

The delay between consumption and payment cannot only lead to impulsive buying and self-control problems, but also influence a person’s ability to connect her own past spending to the fairness of her credit card balance. Previous research on savings for retirement has shown that, when prompted to think about themselves in the future, people’s brains activate areas that are related to thinking of strangers, rather than themselves (Hershfield et al., 2008). This implies a psychological distance between present self and future self. We could argue that a similar effect could exist between the present self — the one who has to cover the costs of the credit card balance — and the past self — the one who had made purchases in the past. Even though we could not find research directly addressing this suggestion, Figures 2 to 5 provide examples of individuals expressing their opinions about their own credit card balances on Twitter as an illustration of this distancing effect between the past and present selves (translated from Portuguese by the author):

The Twitter posts above were collected early January this year. Images are linked to the URL of actual published posts. Note individuals stated intentions to either avoid facing the result of their own past spending or impersonating the credit card financial institution as something bad, as if their spending reflected in the balance was not a result of their own actions.

2.2.2. Framing of Credit Card Limit as Available Money

Abrantes-Braga and Veludo-de-Oliveira (2020) proposed the idea of a credit limit misconception to explain the extent to which individuals believe their credit limits are part of their current income. The researchers studied a sample of Brazilian individuals, and provided evidence that it is one of the determinants of impulsive buying and risky indebtedness behaviour. Past research by Soman and Cheema (2002) had already explored the hypothesis that people use information on credit limits as a signal of future earnings potential. “Specifically, if consumers have access to large amounts of credit, they are likely to infer that their lifetime income will be high and hence their willingness to use credit (and their spending) will also be high.” (Soman & Cheema, 2002, p. 32). Market mechanisms can eventually incentivise credit card misuse and indebtedness even for consumers who initially have the ability to pay off their monthly balances, given that “credit card issuers typically raise the credit limit over time for cardholders with good repayment track records” (Stavins, 2020, p. 65). Investigating determinants of credit card spending and debt by Chinese consumers, Lin et al. (2019) observed that the limit set for a card has positive effects on the total amount spent and on debt.

Therefore, there is plenty of evidence to comprehend the importance of the established credit card limit in signalling availability to spend. In this report we bring the evidence together to propose the idea of credit limits being framed as available money.

Framing is a behavioural issue implying that the way a choice problem is formulated can cause significant shifts of preference (Tversky & Kahneman, 1981). If we consider that credit limit is one of the determinants of spending as mentioned before, the way the credit card limit is presented also can influence spending.

We can argue that credit card issuers are interested in increasing consumers spending as it means more revenue, loyalty and market share. Therefore, there is an incentive for credit card issuers to frame the maximum credit limit as available money to be spent, disregardless of consumer’s income and ability to manage an eventual debt. Figure 6 provides a more tangible illustration of credit card limit being framed as available money in the app of Neon, a credit card issuer from Brazil.

2.2.3. Change in Purchase Reference Point Due to Payments in Instalments

Instalments are an important component of credit card purchases in Brazil: 55% of all transactions split the total price in instalments, as mentioned earlier in section 1.2. This Brazil-specific (Santos & Ferreira, 2021) characteristic of the credit card market results in a behavioural issue as the value of the instalment plays a fundamental role when individuals make purchase decisions. Prospect theory offers an interesting perspective to comprehend this through the concept of reference point, “the earlier stage relative to which gains and losses are evaluated” (Kahneman, 2011, p. 281).

Consumers typically compare the price and the value they attribute to an item, and their own availability of funds to pay for them. However, when purchasing in instalments, usually the price of instalment — a fraction of the total price — is more salient (see two illustrative examples in Figures 7 and 8). This can change the reference point used by the consumer to assess gains and losses resulting from the purchase. The reference point for the value provided by the purchase is not the full price of the item, but a fraction of this, represented by the price of the instalment. The salient instalment price prompts losses to feel less aching and gains to feel more rewarding. Hyperbolic discounting, covered in section 2.2.1., arguably amplifies this effect. Note that the fraction of the total price can be quite small as it is common in Brazil that retailers offer payment plans in 10 or 12 instalments, interest-free (Bertran & Echeverry, 2021; Santos & Ferreira, 2021).

This change in reference point would not be linked to a potential for indebtedness if individuals could consistently keep track of previous purchases and commit to instalments only up to the amount they can repay. Nevertheless, Kahneman (2011) proposes that people substitute difficult questions by easier ones one making decisions. “Can I pay one instalment of BRL 20 every month?” is a cognitively easier question to answer than “Do I have capacity to pay for this BRL 20 instalment added to all the other instalments from purchases I have made before?”.

2.2.4. Anchoring on the Minimum Payment

An anchoring effect happens when arbitrary numbers systematically influence how people make judgments and decisions (Tversky & Kahneman, 1974; Ariely, Lowenstein & Prelec, 2003). Credit card minimum payments are arbitrary numbers in the sense that they are typically percentages of the total balance defined by financial institutions. In Brazil, the minimum payment established by credit card issuers is 15% of the due monthly balance (Ferman, 2016; Bertran & Echeverry, 2021). Credit card consumers usually see both full payment and minimum payment options stated in the balance.

Thaler and Sunstein (2008) and Stewart (2009) suggest that people will repay less their credit card balances if their decisions are anchored on minimum payment. Research shows that setting the minimum payment as a default option can lead credit card users to pay more interest rates compared to previous months when minimum payment was not automatic (Sakaguchi et al., 2021).

The behavioural issues presented above are comprehended within the model a consumer’s path to credit card misuse and indebtedness (Figure 9). Behavioural-informed interventions are important to minimise the negative consequences of credit card indebtedness both to individuals and society.

3. Behavioural Interventions

There is a need for more research on credit card overspending behaviour, as literature on the topic is fragmented and lacks studies (Ming et al., 2020). Overall, behaviourally-informed interventions to avoid credit card misuse and indebtedness should aim to: a) help consumers to deal with self-control problems and connect the “spender” past self with the “payer” present self; b) frame credit limit as borrowed money; c) help people keep track of cumulative instalments; and d) develop a new choice architecture for minimum payment. The next paragraphs bring together intervention ideas from the author connected to relevant previous research on the topic.

One useful strategy to help people with self-control problems is to favour debit cards. It could be possible by increasing salience and appeal of paying with debit cards rather than credit cards. Consider the critical scenario in Brazil today, in which credit cards are used as much as debit cards, but carry a cost of more than 300% annual interest rates for revolving credit and are indeed the main cause of indebtedness in Brazilian households (see 1.2). In this situation, credit card use could be discouraged by explicitly increasing the price of items to be paid with credit, as compared to debit cards. Prospect theory predicts that consumers may feel more intensively the pain of paying more if the reference point is the price with no surcharge, so we can expect credit card use to decrease in situations when debit cards are an option available to the consumer. Additionally, public policy agents should use credit data provided by financial institutions to track back individual spending behaviour and disincentive retailer offers that are likely to make people overspend, for example when a instalment plan of 10 or more instalments is offered.

Interventions should aim to connect the “spender self” with the “payer self” to create accountability between the shopper and accountant, two entities with different time preferences that emerge when credit card is used (Bertaut et al., 2008). Drawing inspiration from Hal Hershfield’s future self intervention (2011), credit card issuers could help clients see themselves in the future and display a self-reflection question before approving a credit card payment: “Do you think you will be happy and satisfied to shell out money to pay for this good within four weeks from now, or will you forget about it? Consider paying with debit.” Naturally, if financial institutions have economic incentives to increase credit card usage, this type of intervention is less likely to be implemented.

Given that credit limit misconception has a significant impact on impulsive buying and indebtedness (Abrantes-Braga & Veludo-de-Oliveira, 2020), policy-makers should regulate the way this information is displayed by credit card issuers. A simple first step could be made by changing how credit card limit is framed to the consumer. It should not adopt the same visuals as the available money in the checking account balance, and money spent on credit cards should carry the visuals of a debt, for example by being printed in red colour until they are repaid. Similarly, interventions that help consumers keep track of cumulative instalments by using System 1 thinking, rather than effortful System 2 operations (Kahneman, 2011), are welcome to bring salience to the total amount of purchases adding up for the next monthly balances. This is especially alarming in the case of low-income consumers, as reported by Santos & Ferreira (2021) who have researched a peripheric neighbourhood in São Paulo: “Ongoing indebtedness has become a reality for many; their (frequently unstable) incomes cannot always cover the cost of the (frequently inflexible) instalment payments they have accumulated” (p. 13).

Finally, and perhaps most importantly, the choice architecture of minimum credit card payment needs to be seriously reconsidered. If in countries where interest rates are lower, minimum payment leads consumers to pay more interest rates due to the financing of revolving credit (Sakaguchi et al., 2021), in a 300% annual interest rates scenario it can potentially create a debt that is very difficult to repay. Figure 10 illustrates how minimum payment is presented in the credit card balance by one of Brazil’s most relevant card issuers, Itaú:

Sakaguchi et al. (2021) suggest that minimum payment amount should be manually selected to increase chances that consumers will minimise the total amount in revolving credit. If a consumer cannot pay the whole amount of the credit card balance, but can pay any amount higher than suggested by the automatically calculated minimum, potential to indebtedness is lower as interest rates on revolving credit will be smaller. Therefore, credit card issuers should not display the default minimum payment with almost as much salience as the total payment due.

4. Evidence Gaps

The case of credit card misuse and indebtedness in Brazil directly addresses the standard economic assumption that if interest rates are high, people will borrow less money. On the other hand, financial institutions can argue that high interest rates precify the risk of default they take. The behavioural issues mapped in section 2 suggest that “supposedly irrelevant factors” (Thaler, 2016) can have a significant impact on people’s capacity to pay off debt, apart from elevated interest rates. Policy-makers should invest resources to understand the association between interest rates, behavioural factors that lead to credit card misuse, and indebtedness.

Given the behavioural issues addressed in this report and the suggested solutions, some of the evidence gaps in research that should be clarified are:

How do individuals incorporate credit card limit to their spending budget? What are the mental accounts they create? Abrantes-Braga & Veludo-de-Oliveira (2020) suggest that the concept of credit limit misconception should be tested empirically. Exploring how people make decisions to pay with debit or credit card, associated with the type of purchase, can shed some light to this.

Do individuals accept paying more money for a product if they are going to pay with a credit card, or an instalment plan? We propose an intervention to make credit card payments feel more costly — and painful — to the consumer as compared to debit. However, there is evidence in the literature that intertemporal discount is very elevated and people would pay twice as much — on tickets to a sports game — if they could pay with credit rather than cash (Prelec & Simester, 2001). This type of research should be developed in Brazil to assess if increasing credit card costs would minimise misuse. Notice also that people can use credit cards to complement their monthly income (Santos & Ferreira, 2021), not only to purchase hedonic goods. Lack of financial education and ability to understand and calculate interest rates also determine credit card misuse and indebtedness among Brazilian citizens (Abrantes-Braga & Veludo-de-Oliveira, 2020; Ferman, 2016; Flores & Vieira, 2014; Santos & Ferreira, 2021). One question related to this for which I found no evidence is if consumers misunderstand interest free instalments with interest free credit cards.

Do people have a clear understanding of the consequences of financing revolving credit by paying the minimum? Do they feel like it is a good decision? Would they pay more than the default minimum if they had to manually input an amount to pay, rather than going with the default amount set by the issuer? Minimum payment is a relevant source of earnings for financial institutions and an arguably predictor of credit card misuse and indebtedness (see Bertran & Echeverry, 2021; Sakaguchi et al., 2021; Stewart, 2009). There are avenues for future research to develop experiments that assess how minimum payment choice architecture influences the amount of debt consumers owe.

5. Ethical Concerns

There is relevant debate in terms of applying behavioural-informed solutions, and assessing ethics can be complex (Lades & Delaney, 2020). Citizens are invariably harmed by being indebted, either by decrease in financial and overall wellbeing — as mentioned in section 1 — or by limited future access to credit systems due to defaulting. One could argue that ethics in this scenario should also be interpreted from the perspective of the consumer who intentionally does not pay off her debts. Here, we assume people do have an initial intention to repay the credit they borrow and not be indebted. Otherwise, credit card issuers would not be interested in lending them money. The behavioural intention of not repaying credit is investigated in more depth by literature not covered in this report (see for example Bursztyn et al., 2019; and Ding et al., 2009).

Are the interventions hereby proposed ethical? It is important to keep in mind the local context and costs of the status quo. Credit card interest rates in Brazil are so high that within one year the debt an average person owes to a credit card company equals to three to four times the amount initially borrowed (Bertran & Echeverry, 2021). Financial institutions earn from this (Chakravorti & Emmons, 2003), and therefore interventions aiming to adjust their practices should be the main target of ethics assessment. Helping consumers deal with self-control problems and keep track of cumulative instalments, framing credit card limit as borrowed money and developing a new choice architecture for minimum payment are behavioural interventions that could only be detrimental to the profits of organisations making money on consumers’ cognitive (human) limitations. The role of policy-makers — notably Brazil’s Central Bank — is to make sure interventions are fairly requested to be implemented by all credit card issuers, and that citizens understand the reasoning and justification behind new policies.

For this matter, it is wise to apply a framework to guide ethics assessment. The FORGOOD framework suggests seven core ethical dimensions to evaluate behavioural policies: “Fairness, Openness, Respect, Goals, Opinions, Options and Delegation” (Lades & Delaney, 2020, p. 3). Note that all interventions proposed are nudges in the sense that they incentivise certain behaviours but do not prohibit any course of action (Thaler & Sunstein, 2021).

One question that might arise is that labelling credit card payments as more expensive than other payment methods such as debit cards is unfair to retailers. This ethical concern deserves further appreciation in light of the Brazilian context. On one hand, credit cards are the most frequent cause of household indebtedness. On the other, credit cards can finance essential needs for low-income populations (Santos & Ferreira, 2021).

In addition to this, a second question that might arise is that people are free to spend money and default, if this behaviour corresponds to their preference. In this case, the interventions can still be considered ethical in the sense that people are not in any case prohibited to spend their credit limits and not repay their debts.

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