Why pay more? We hear that a lot—it is the tag line of many store sales and a popular phrase among car dealership ads. We love the idea that we might be able to save a few dollars, yet we are probably spending more. Consider this research finding: McDonald’s customers spend 47% more when they pay with credit rather than cash. Another experiment at MIT supports a similar conclusion. A group of participants bid on tickets to a Boston Celtics game; half of the participants were told they would have to pay cash, the other half were told they had to pay with a credit card. The group paying with cards bid on average twice as high as the group paying with cash! This consumer habit is good news to the businesses who are happily taking your money. Even though there is a charge that merchants must pay when accepting a credit card charge, it seems that they are still making out well.
So why is it that we spend less when we have cash versus a credit card? Well, there are some basic economic and psychological principles at play here. First, we can actually see our cash decreasing as we spend cash. There are even some brain-imaging experiments that point to different brain activity when we pay with cash versus credit—it has been shown that paying with credit cards reduced activity in the insula, the area of the brain associated with negative feelings. So we are far more likely to feel fine about a high price tag when we’re paying with a credit card, and that is how we end up spending beyond our means.
Also, we budget better in cash—if you leave the house with only so much cash, then that is all of the money that you have. Otherwise, you have to go and get more cash and on the way to get that cash you have to deal with the internal conversation you are having about how you told yourself that you would not be getting more cash.
Further, with a credit card, you just hand it over and you deal with it later. This is a very simple concept—you get a short term reward with long term consequences. It is kind of like getting a short term loan or renting furniture. In the end, you get a nice TV or great couch or quick cash, but in the long term you will pay HUGE interest for the use of the products or the money. This is just not a good idea, but again, we want to feel good right now.
So, how do you resist the pull of the credit card? Well, there are several options. First, you could get rid of your credit cards. You can still survive with having a checking account and using cash. But this won’t help you establish and maintain a credit history.
If you are going to get yourself a credit card, be sure to keep all of your receipts and enter them into your financial planning system so that you are aware of what it is that you are spending through the month so that your credit card bill will not be a surprise. If you know that you are an impulse spender, you could leave the credit card at home and only bring cash with you on days that you might be impulsive. Or, you could even get a prepaid debit card—that way, you cannot spend over a certain limit, because there is no more money left in the account that the card is linked to. (Though check the fine print; prepaid cards may not help build your credit because they do not report to any of the three major credit reporting agencies that credit issuers and most lenders look to when granting credit: Equifax, Experian and TransUnion.)
No matter what, if you really want to save money when using your credit card, then there is really one very simple thing to do—pay your card off every month. DO NOT hold a balance, as that is how you will really be spending more money than you want to.
You do not need to get caught off guard with the ease of purchase power that a credit card offers to you. They can for sure be very helpful and useful, but they can also get you into trouble. You need to think whether the interest on that ten dollar t-shirt is worth it if you cannot pay the bill off at the end of the month.
Image: Lovelorn Poets, via Flickr.com