Credit cards have become a ubiquitous feature of modern-day life; so ubiquitous that a number of countries, especially Sweden, are seriously looking at going cashless. 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?
Psychology and Consumer Behavior
In recent months we have learned how social media companies, such as Facebook and Twitter, have purposely developed their platforms with human psychology in mind. ‘Likes’, comments and other features of social media were purposely developed to be addictive, with the goal of keeping you glued to the platform and engaged. This, of course, allows the businesses behind the platforms to make more money off of advertising and data analytics than would otherwise be the case. But exploiting human psychology to drive corporate profits isn’t limited to the social media world – and it isn’t a novel concept. Psychology can play a role in even the most mundane financial transactions.
For instance, a 2011 study by Minoj Thomas found that paying by credit card, as opposed to paying with cash, had a noticeable and detrimental effect on a person’s impulse control. In that study, grocery shoppers were found to be inclined to make more impulse purchases and to purchase more unhealthy foods when paying by credit card. They further found that paying in cash had a “pain of payment” effect that credit card payments did not, and this led to generally greater self-regulation when it came to a person’s vices.
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. This led to overconfidence and a noticeable tendency to overspend. This effect was most noticeable in younger consumers with higher credit availability.
Going even further back in time, all the way to 1986, Richard Feinberg wrote an article in the Journal of Consumer Research entitled: Credit Cards as Spending Facilitating Stimuli: A Conditioning Interpretation. In his research, Dr. Feinberg found that the very presence of visible credit card logos increased an individual’s willingness to spend, and even to donate to charity.
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. It also confirmed numerous previous studies that demonstrated a dulling of the “pain of paying” when paying with a credit card instead of cash, which tended to encourage people to spend more than they would otherwise be comfortable with. The results suggested that consumers have been conditioned to associate credit card logos with consumption and that association may motivate purchasing behaviors.
This explains why nearly every retail establishment the world over has credit card logos prominently displayed. They can be found on the front door, in the windows, by the cash register and are often on display throughout the premises. They’re not just serving notice that you have the option of paying by card, they are actually priming you psychologically to spend more. It’s very smart marketing.
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.
For instance, if you took out a loan of $10,000 at an interest rate of 20% and wanted to pay it off in 3 years, you’d have payments of $372 per month. However, on a credit card that same amount, at the same interest rate, will have a minimum monthly payment of as little as $175 (interest amount plus $10). Of course, the lower payment means it will take about 15 years to pay off the debt. Why is this an issue?
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.
Important Disclaimer: the information above is for general informational purposes only and does not in any way constitute an offer for the purchase or sale of any security and is not intended to be considered comprehensive or personalized financial or investment advice. themoneygeek.info assumes no responsibility for the use or application of this information. Always consult a tax, investment, or other appropriate professional before adopting any new financial strategies.
I am an accredited Financial Planner with 23 years of experience in the financial services industry. During the course of my career I completed hundreds of financial plans and recommended and sold hundreds of millions of dollars of investment products. I believe that financial independence is a goal anyone can aspire to and I am passionate about helping others to live life on their own terms.