Why Do Some Singaporeans Have Credit Card Debt?

The Straits Times reported last year that the total amount of overdue unsecured debts in Singapore stood at S$288.4 million. This amount was owed by just 5% of Singaporeans who make use of credit cards and personal loans. As if that wasn’t bad enough, the total amount of debt increased by 75% from 2011.

The number of Singaporeans getting into credit card debt is climbing at an alarming rate. Even more worrying, a report by the DP Credit Bureau found that younger credit cardholders (between 21 to 30 years old) were twice as likely to default on their outstanding balances.

With rewards, high-interest rates, and late payment fees, cardholders are incentivised to keep their account in good standing. But certain cognitive biases can explain why some Singaporeans can’t keep a clean balance sheet.

The Curious Effects of the Anchoring Bias

To understand why some Singaporeans have credit card debt, we have to understand what the anchoring bias does.

In a nutshell, this makes us use the most recently known information as a reference point when making decisions. In situations involving numbers, anchoring makes us refer to the first number we see or remember, no matter how completely unrelated the number is.

In a study conducted by MIT, MBA students were asked how much they were willing to pay for a series of random items, whose value they did not know. However, before they began bidding, they were told to write down the last two digits of their own Social Security Numbers.

The researchers found that the students’ bids were significantly influenced by the last two digits they had read from their Social Security Numbers. This was despite their Social Security Numbers having nothing to do with the value of the items being bidded for.

More tellingly, for the same item, those who had higher last digits bid a higher price, while those with lower last digits bid lower.

Because cognitive biases affect us all, could anchoring bias also be affecting Singaporeans, contributing to the growing debt problem? If so, how?

The two most salient sets of numbers here are the credit card limit, and the minimum monthly payment.

How Anchoring on the Credit Limit Makes Singaporeans Spend

First, let’s look at your credit limit. Consider the two scenarios below.

Scenario A: You bring home S$2,400 a month. You see your dream laptop going for $1,799. Which of the following statements do you agree more with?

1. The laptop seems affordable.

2. The laptop seems expensive.

Scenario B: You bring home S$2,400 a month. You have a S$10,000 credit limit on your credit card. You see your dream laptop going for $1,799. Which of the following statements do you agree more with?

1. The laptop seems affordable.

2. The laptop seems expensive.

If you felt that the laptop was more affordable in Scenario B, you’re likely to have credit card debt, or are at risk of incurring some.

It appears that by anchoring on the credit card limit, we become more willing to spend more money, even if it’s money we don’t necessarily have. In fact, research shows a correlation between thinking about the totality of one’s financial accounts and increased spending.

How Anchoring on the Minimum Payment Drives Up Credit Card Interest

If the credit limit makes you spend more money, the minimum monthly payment can keep you mired in debt.

The University of Warwick found that credit users with an outstanding balance they could not clear each month become fixated on the minimum monthly payment printed on the statement.

The study’s participants were found to orient their bill payments towards the minimum sum, as if it was a suggested amount to pay. This was observed even among users who could afford a larger payment.

When the minimum monthly payment amount was raised or removed, credit users made larger payments per month.

Further research found that even if the minimum was changed (to enable debt repayment within 36 months) users once again anchored on the indicated figure.

This time, median payment reduced, suggesting that cardmembers who were paying more (in the absence of a minimum) had reduced their monthly payments as they oriented towards the anchor.

In other words, because of anchoring, the minimum monthly payment keeps credit users in debt by influencing the rate at which they clear their outstanding debt! This means Singaporean credit card users with rollover debt may be unwittingly paying more interest than needed.  

Overcoming the Anchoring Bias

Luckily, anchoring bias is one of those rare few cognitive bias that we can use to our advantage,

If you have rollover debt, we suggest ignoring the minimum sum on your statement. Instead, consciously anchor yourself on a figure (higher than the minimum, of course) that you can comfortably pay off each month.

A good guide would be to choose a figure that will let you pay off your debt in 12 months or less. Remember to take into account the interest on your debt. Here’s a simple way to estimate what your monthly payment should be.

(Current outstanding x 1.yy) / 12, where yy = annual interest rate.

Let’s say you owe S$5,000 on a credit card with an annual interest of 28%. The calculation would then go like this:

• Step 1: S$5,000 x 1.28 = S$6,400

• Step 2: S$6,400 / 12 = S$533.33

You should be paying S$530 each month, in order to pay off your debt within a year. If you cannot pay off in a year, then try 18 months, 24 months, etc. But remember that credit card interest is applied every month, so the larger a payment you make each month, the lesser you’ll pay overall in interest charges.

Once you’ve calculated your monthly payment, put the figure somewhere you can see every day. Anchor yourself by looking at this figure each time you open your bill.

One Trick to Using Credit Cards Responsibly

Remember, a credit card limit is how much money you can borrow. Credit card limits also do not reflect the applicant’s ability to pay. (For example, I have a credit card with a limit of almost S$12,000, even though during the time of application, my monthly salary was only S$3,500!)

To stave off overspending, write down the actual amount you can afford to spend and stick it on your credit card. This then becomes the real credit limit on your card. When you hit that limit for the month, put your card away.

When used responsibly, credit cards are a great financial tool that can give you rewards and save you money. Understanding how anchoring bias affects you will help you get out - and stay out - of credit card debt.

When In Doubt, Lower Your Interest 

If, despite your best efforts, you find yourself struggling to get out of credit debt, you should focus on lowering your interest.

Should you happen to be owing an significant amount - over 12 times your monthly salary - paying even just the minimum sum can prove impossible. In this case, lowering your interest will lower your monthly payments and make your cashflow more manageable.

One way to cut your interest is with a Debt Consolidation Plan (DCP), the latest debt management tool offered by Citi.

A Citi DCP offers interest of 10.5% per annum, which is significantly lower than credit cards. (The latter have interest rates that are approximately 25% per annum.) Slashing your interest rates gives you massive savings in interest payments, lowering your overall debt amount.

With reduced interest rates and a smaller outstanding debt, your monthly payments will also come down. This helps you have a better cashflow, as you'll have more cash to meet other obligations, or to put into emergency savings. To further help you meet daily financial needs, Citi DCP comes with a revolving credit facility equivalent to 1 month's salary.

One more benefit of applying for a DCP is the certainty you will regain. When you sign up for a DCP by Citi, you will be allowed to choose your repayment period, which ranges from 3 to 7 years.

This not only allows you to repay your debt at a comfortable pace, you also gain a concrete forecast of when you will become debt free. This is crucial in dealing with large debts, as having a timeline to follow is powerfully comforting and very motivational.