Payments · policy

Mainstream Monday: Credit cards – are they working for you?

You may not think much of the decision to use cash versus credit versus debit on a day-to-day basis, but there’s a lot going on behind that decision (and its implications for your bank account), even if you’re not consciously aware of it. I’ve been seeing lots of new data and studies regarding how different types of payment methods lead people to make different purchasing decisions. In a world where new ways to move money like Venmo, Paypal, and Bitcoin are popping up every day, it’s no surprise that people are behaving unexpectedly and often irrationally when it comes to how they treat the different vehicles for their assets and liabilities.

Take the simple case of credit cards. These are by no means new, but study after study proves that people do not act rationally when it  comes to how they spend money on credit. This article from The Atlantic does a great job reviewing the currently literature on the subject. Basically, there are three problems:

  1. People underestimate the value of money when using credit cards. One study found that people were willing to pay twice as much for the same good when purchased with credit versus cash.
  2. People don’t always comprehend how credit cards work with respect to compound interest work. A study on financial literacy found that only about 1/3 of the population actually understands how compound interest works.
  3. People don’t pay off their credit card debt. Credit card debt has increased 1,500% per capita since 1980.

All of this is  extremely scary, especially given that we may be moving away from cash and people are becoming more and more dependent on these less tangible types of payment methods. It’s important to find ways to make people grasp that plastic and/or virtual money is still money and shouldn’t be treated all that differently.

The article cites studies that present a couple of policy suggestions about how to get people to be more responsible with their plastic. One is to text people reminders about their saving goals. Another is to have a card that changes colors when the limit is approached. Printing credit card balances on every receipt is another idea. I think that all of these are valid suggestions that are worth looking into, but I have something else to throw in the ringer: credebit cards (a credit/debit hybrid).

I was recently introduced to some preliminary research demonstrating that when people were given the option to pay off their credit card bill by purchase, rather than as a lump-sum, they actually pay off more of the balance. There are several possible explanations as to why this is, but my belief is that people like the satisfaction of checking things off of lists and the bill is easier to process if its broken down by tangible assets (their purchases). If they see something like groceries on their credit card bill, it probably seems silly to be paying interest on that so it becomes a priority to pay off. Something like a computer on the other hand, people may be more willing to continue paying interest for, given that they are likely still reaping the benefits of that purchase. Those groceries, on the other hand, are long gone.

grocery store

With a credebit card, consumers would have the option with each purchase as to whether or not it comes out of their bank account or goes toward their credit limit. This gives consumers more flexibility , but also inherently forces them to think about how their purchases align with their saving goals. It would also still leave room for incentives and rewards programs that people love and often drive them to overusing credit cards. It helps solve the 3 problems I note above by:

  • Normalizing the value purchases on the card since some of them will be deducted directly from the bank account
  • Requiring people to think about whether or not they potentially want to borrow money for a purchase right when they are making it
  • Decreasing the number of transactions that turn into debt with compound interest

Obviously, better financial literacy would also be an ideal part of the solution, but we aim for progress not perfection.  The best thing that policymakers can do is implement a system that sets people up to make the right choices. Pretty much all of the research out there about this says that such a system has to involve triggers that get people to think about the decisions they’re making.

The infrastructure for such a solution already exists, but it would be tricky to get credit card companies on board. They love those compound interest profits and something like this would be scary for them. Read: credit card companies profit off of you being financially irresponsible and they don’t want to change that. Obviously, this is something that you can already do yourself if you’re diligent about sticking to a budget, but that isn’t always the case.

budget-cat

I love that payment options are becoming more varied and inclusive and I think it’s going to work wonders for the world economy, but it can also make personal finance more complicated. A Federal Reserve study of consumer payment choice over the past 6 years has consistently shown that consumers rank convenience as one of the most important factors in payment choice: people want payments to be simple. Giving people the option to have their cake and eat it too when it comes to the benefits and convenience associated with credit cards without burying themselves in mountains of debt seems like a win-win.

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