Credit cards are convenient (in terms of both payment processing and record keeping), they are necessary for some transactions (like renting a car or reserving a hotel room), and they provide appealing perks such as points programs or cash back features that make them all the more attractive. But are credit cards merely an attractive cash alternative, or is there more going on behind the scenes that needs to be considered?
The Greatest Marketing Program Ever?
Probably the most insidious, and perhaps least-known aspect of credit cards is how they work to help promote, market, and increase the cost of consumer goods. The focus of any retailer is, of course, to get as many people as possible to spend as much as possible at their business, and credit cards have provided significant assistance in this regard.
A 2002 study by Dilip Soman and Amar Cheema found that credit card shoppers tend to apply inappropriate metrics when assessing the cost and affordability of a purchase. Purchasers tended to compare the cost of an item to their available credit, rather than to their cash on hand or money they have available in the bank. Similarly, in 2008, the study Monopoly Money: The Effect of Payment Coupling and Form on Spending Behavior by Priya Raghubir and Joydeep Srivastava confirmed that the mere presence of a visible credit card logo increased a person’s willingness to spend.
Discounting The Savings
There are many, many more studies that can be referenced in addition to the ones mentioned here, but almost universally they come to the same conclusion: credit cards encourage and increase consumer spending, often to the financial detriment of the cardholder.
This is why I tend to fully discount the financial benefits of cash back offers and points programs. These programs often offer a reward equal to 2 or 3 percent of your spending. But if using a credit card is subconsciously causing you to increase the amount you spend in the first place, are you really better off? It is very likely that your spending is being increased by a much greater percentage than the reward amount, completely nullifying any financial benefit.
The Minimum Payment Trap – Hiding The True Cost Of Debt
A final area where credit cards take advantage of human psychology is in understanding the true cost of debt. The issue is that in the modern consumer world people are being conditioned to ascertain the affordability of a potential purchase based not on the purchase price, but on whether they can make the monthly payments. Credit cards make consumer goods appear more affordable than they really are by essentially stretching repayment into the very distant future. This has a tendency to encourage people to take on debts that they may never be able to repay, as meaningful repayment of the principle has essentially been removed from the equation.
This can drive very self-destructive behaviors. For instance, it is not uncommon for people to take a low interest loan and pay it out with a high interest credit card. This is because the monthly payment drops and the consumer “feels like” they are saving money. In our example above, a $10,000 3-year loan at even 4% would still require a payment of $295 every month. For a struggling family, the temptation to move it to a 20% credit card where the minimum payment may only be $175 per month can be overwhelming.
How Credit Cards Kill – And How To Not Be A Victim
Being deeply in debt, particularly if you have become discouraged in your ability to ever pay it off, can have a serious impact on your mental health. A 2018 study in the UK found 1 in 6 people with financial problems had experienced suicidal thoughts. Of course, credit card debt is one of the leading contributors to serious financial difficulties for individuals and families alike and has caused deep-seated and long-lasting anguish for many.
My recommendation is this: if you have good cash flow, your spending is well controlled, you are happy with your net worth and you are on track to meet your financial goals, then keep using your credit cards. For the rest of us, maybe it’s time to put them away. Somewhere well out of reach. In my family, we moved to using a cash allowance method for our spending years ago and noticed it almost immediately reduced our spending by about 25%. Try it yourself. You may be surprised at the difference it makes.