Guide to Credit Cards: How Credit Cards Encourage You To Overspend
The more people charge to their credit cards, the greater the profits made by the credit card companies. The credit card company receives a percentage of each transaction as a merchant fee. But the big money comes from the credit card users: the more you spend using your credit cards the higher the probability you will borrow money from the credit card company at steep interest rates, get hit with fees for exceeding your credit limit, and incur larger penalties for late payments.
So credit card companies have a strong incentive to encourage their customers to spend more money using credit cards. They succeed. A Dunn & Bradstreet study found that people spend 12-18% more when using credit cards than when using cash. And McDonald's found that the average transaction rose from $4.50 to $7.00 when customers used plastic instead of cash.
That's great for the credit card companies, but often lousy for the financial well-being of the credit card user. Credit cards can make it harder to budget, harder to save for college and retirement, and can get you into debt. To avoid overspending, it helps to understand how credit card companies encourage you to spend. Here's how:
The psychology of credit cards themselves makes it easy for you to spend more money than you should. If you're going to use credit cards wisely and profitably, this is crucial to understand.
When you charge something to a plastic credit card, it doesn't feel as though you're really spending money. Why not? Because when you spend cash, you tend to withdaw an amount from your checking account to cover multiple purchases over a certain time period - say a few days or a week. That gives you an informal budget: "Here's how much I withdrew, and it should last me X days". When you spend that cash, you're aware that you are using up that informal budget. If you use the cash faster than you had planned, you're immediately aware that you might be overspending. In other words, using cash reminds you that you have a budget (even if its informal), and gives you a sense of whether you are within your budget.
That's not true of credit cards. When you charge a purchase to a credit card, there's nothing to remind you at the point of purchase how much you have previously charged to the card or how much money you have spent recently. As a result, it's much harder to stick to a budget if you use credit cards, and it's easy to overspend.
Next, impulse purchases are also much easier with credit cards. It's far easier to make a large impulse purchase if you don't have to find an ATM machine to withdraw cash from your checking account.
Credit card companies also encourage you to buy more by offering rewards for increased spending. Rewards are often tiered depending on how much you charge to your credit card. Credit card companies sometimes give their customers special rewards for using their credit cards during peak spending periods such as the holidays, or using their credit cards with particular merchants.
Finally, credit card companies make it easy to spend more than you should by making it easy to borrow money. That's what we'll look at next.