The Psychology of Credit Cards
Credit cards are indispensable in our modern economy. They facilitate economic transactions, save consumers from carrying cash and finance purchases on the spot. They also come with a huge drawback—they often encourage overspending, which can undermine an individual’s financial security, now and in the future.
Why We Spend More with Credit Cards
There is ample research that shows that individuals, when paying by credit card rather than with cash, are willing to pay more for a desired product or service. One study showed that consumers were willing to pay as much as 83 percent more for products and leave, on average, 13 percent higher tips when paying for a meal by credit card.1
There are several reasons for this.
- When using a credit card, individuals focus more on the benefits than the cost. This focus on benefits makes credit card users less price sensitive.
- Small purchases look smaller when compared to the monthly credit card bill. That $50 charge for that cool gadget doesn’t appear as expensive in the context of overall monthly charges of $1,200.
- Credit cards distance the pain of spending money, especially when weighed against the immediate benefits enjoyed by the purchase.
- Credit cards erode financial discipline. For instance, consider that you want to spend no more than $250 for a present. If you went to the store with cash, you’d need to make sure you bought something for that amount or less. If you go with a credit card and see something nice for $275, you are more likely to spend over your budget than if you just had cash.
- Price increases are less noticeable when charged to a credit card. For example, state governments have found that they get less resistance over toll increases from drivers who have their tolls electronically recorded and billed to their credit card.
Taking Back Control
Credit cards understand this psychology. It’s one reason that issuers offer rewards programs; they want to encourage spending.
Individuals can take control of these behavioral forces and the social pressures to spend by using cash more often to make purchases, leaving the credit card at home, recording all credit card purchases each day so the “pain” of spending is more contemporaneous to the purchase and following a budget to support greater financial discipline.
Please reference disclosures: https://blog.americanportfolios.com/disclosures/