The downside to credit cards
After writing articles such as Why Credit Cards are the Best Way to Pay and Are Two Cash Back Credit Cards Best? I have pretty well established on this site that I am a firmly pro credit card. This weekend I had an interesting conversation with an anti credit card advocate who made some pretty good points about why credit cards may not be as good an idea as I make them out to be. Most of the points that were made I had answers to, but one of them was a little more troubling. With a great deal of artistic license, here is a summary of the conversation:
Point 1: You aren’t really saving money when you earn rewards because you are paying a lot of interest on those credit cards
My response: No you’re not. When you pay your credit card off each month you are never charged interest.
Point 2: The rewards you are earning are earned off the backs of all those poor suckers who can’t pay off their balance each month.
My response: That may be true but it’s an irrelevant fact. The credit card companies would not lower their interest rates one bit if they suddenly didn’t have to pay me cash back each month.
Point 3: Most people don’t save their cash back rewards, they just spend it again.
My response: Money is a fungible commodity and it is incorrect to look at this money in your account being for one purpose and this money being for another. It’s all the same money, and if you can manage to make a couple hundred bucks more, then that is never a bad thing. No one in history has ever suggested you should make cash back rewards the cornerstone to your savings plan, it’s just a nice little bonus.
Point 4: Peer-reviewed research has concluded that people spend more with a credit card than they do with cash. It’s easy to do.
My response: You’re right. That is a problem.
Why people spend more when they use credit cards
Several scientific studies have shown that people spend less when they pay with cash because when you lose money you experience a kind of pain. Paying with credit cards is a less painful experience because you know you won’t have to actually pay the money until sometime next month, and the idea of future pain doesn’t have as strong an effect on us as the prospect of being in pain right now.
This makes sense, but I wonder if there is a way around this problem. Credit cards are a great way to pay because of their convenience and all the different kinds of consumer protection they offer, but those benefits are outweighed very quickly if they cause you to spend even a tiny bit more than you would have with cash.
What we need is a way to make using credit cards as painful as using cash.
Making credit cards more painful
I thought about some of the habits I have involving my credit cards, and I think some of them might make using credit cards seem more real, and less like an abstract idea that I will have to pay it back someday.
First, I review my credit card activity and check my balances several times a week. I hate seeing the balances go up up up throughout the month. When a balance is particularly high in relation to the day of the month I get frustrated and look for ways to spend less for the rest of the month. I take great pride when my balance is unusually low and it makes me hopeful that I am on track to meet my financial goals. Watching your balance go up seems like a good way to make credit card spending more painful because it seems more real, and makes it more difficult to think of as something you can put off. Of course, frequently checking your transactions is a good idea anyway, as it will help you identify fraud quicker if there is ever a problem on your account.
Next, I have a budget that is continuously updated. I use mint.com to track my budget and set spending limits for myself each month. For example, I have a budget of $100 each month for entertainment. If I spend $10 on a basketball ticket then I can see my budget go down to $90 for the rest of the month. When I spend less than the allotted amount, the balance rolls over as a bonus amount next month. Once again, I believe this strategy makes credit card spending more painful because each time I use my card I can see that it takes away from the amount of money I get to spend on fun stuff the rest of the month.
The last strategy I use to make credit card spending more painful is that I have my payments set up to be automatically pulled out of my checking account each month in full. In this way the credit card balance is not an abstract idea of money I will eventually have to pay back. It is instead money that is as good as gone because I know the money that is spent will absolutely, definitely be paid. Setting up full automatic payments is also a good way to make sure you will never have to pay interest or late fees to credit card companies which we can all agree is a good idea.
Those are my non-scientific solutions to the scientifically proven problem that people don’t experience enough pain when they pay with a credit card. Perhaps I am being naïve, but I truly believe that those strategies work for me, and take away the delay in unpleasantness that cause people to spend more with credit cards.
I also understand that not everybody is like me. I have met people who tell me they can’t use credit cards because they know the cards make them overspend, and I applaud those people for being honest with themselves enough to close down their credit cards and add the hassle of dealing with cash to their lives.
What about you? Do you believe that you can trick yourself into thinking that credit cards are as painful to use as cash? Let me know in the comments.