There are two sides to the credit card debate:
- The first says that it's ok to use credit cards (and even try to maximize the amount you put on them to get the most rewards) as long as you follow certain guidelines such as only buying items in your budget, paying of the cards every month, etc. This viewpoint believes that people can control themselves and are responsible for their actions. This is the side I personally advocate.
- The second says that credit cards are evil and that you should stay away from them. This viewpoint says that people naturally spend more with credit than they would otherwise and that people can't control themselves (thus, they shouldn't have credit cards.) This view is espoused by Dave Ramsey (though he does accept credit cards.)
These two viewpoints can be debated forever, but what I'd like to focus in on is one key issue: does having a credit card really make you spend more? Let's start with this piece that quotes a study on the issue:
In order to answer that question, we have to look at the behavior of people who use credit cards, versus those who don't. Dunn and Bradstreet did a study which made this comparison, and the results that they found were quite surprising. Statistically they found that on average you will spend 12-18% more when making a purchase with a credit card as opposed to cash. They also discovered that the average McDonalds transaction increased from $4.50 to $7.00. When they looked at vending machines, the average transaction size nearly doubled.
This point was brought up by a reader who commented the following on my post titled Becoming a Money Manager:
I agree with most of this, but I couldn't disagree more with your stance on using a credit card.
Some bills I pay through auto-debit, while others get paid through my bank via bill pay, thus, no postage costs.
When I use my debit card for everything, I get cash back every month from my bank. Usually it's about $7 or so, sometimes more, but usually not less.
The bonus is that I never have to sleep with the snakes in the credit card industry. I never spend more than I can, and I never have to worry about a late fee. I know, I know, "I pay it off every month..." If I had a nickel....
There's also the study done by Dunn and Bradstreet about credit usage that is frequently mentioned here, but most folks collectively deny it because they don't believe it or they think it doesn't apply to them... You're not spending my money, so I really don't care what you do, but to deny something that's been proven many times is just ignorant. See the hyperlink for more info on credit use and the Dunn and Bradstreet study. It's just one example, there are many more out there that show the same thing. You should really address this issue sometimes if you really want to help people, as I'm assuming your blog is designed to do.
We'll get back to this comment in a minute, but for now, here's a rebuttal from another reader of that post:
This isn't so much a comment on the post, but a comment on Tom's comment. Even if there is a tendency for people to spend more when using a card (though the notes on the link seem to question whether that D&B study is accurate), this could be simply an effect of selection bias.
For example... I go to McDonalds for lunch, and pay with cash, because I have an aversion to using a credit card for a $5 charge. I probably have the cash on hand and feel that it’s simpler. For that matter, some merchants have a transaction minimum for accepting credit card payments (though maybe not McDonalds).
Second scenario: I go to McDonalds and buy dinner for my family for $20. I don't have a $20 in my pocket, so I charge the meal. Everything is the same, only I feel more comfortable using a card for a higher dollar transaction.
So, the reasoning isn't "well, I'm using a card, so I may as well Supersize it since its not real money", its different kinds of transactions for cards and cash.
While your point may be correct for "most" people, I hope you can admit that there are some out there that use credit cards to our advantage and don't overspend. Even Dun & Bradstreet admits it implicitly in this quote from the article:
"Statistically they found that on average you will spend 12-18% more when making a purchase with a credit card as opposed to cash."
"On average" being the key words. Like Colin pointed out, when I go to Starbucks to get a coffee, I get the same coffee whether or not I pay with cash or credit. Also - what about the fact that debit cards are issued through either Visa or Mastercard - so you are in fact dealing with "snakes" in the CC industry.
Like I said before, using the credit card for everything but a few bills that are autodrafted smoothes out my cash flow and makes planning what to keep in checking and what to move to higher yield MM account much easier. But at least you have a plan Tom, that's more than most people.
Ok, so maybe people overspend by simply having a credit card and maybe they don't. To me, the key question left remaining is WHY they supposedly overspend if they have a credit card. Back to the Dunn and Bradstreet study for some potential reasons:
One of the reasons could be that credit cards make it much easier to spend money. When you make use of a credit card, all you have to do hand your card to the cashier and sign your name to the receipt. You don't have to worry about if you are spending too much money, and there is no emotional connection that you are letting money leave your possession. When you pay in cash, you have to stop and think about whether or not you will have enough to pay for the rest of your purchases until you go and get more money from the bank. There's an emotional connection between you and your money, and when you let it go, it hurts a bit to do so.
With credit cards, you are also much more likely to make large impulsive purchases. This is because you have access to a lot more money right away than if you were only carrying cash around. You might carry around $50 with you if you paid in cash, but with a credit card, you have a $10,000 limit or so for purchases! You can buy what you please on the spot. With cash, you have to go down to the ATM or bank and take the money out.
Ok, so there are a lot of ideas/thoughts here. Let me address the major ones I see:
- Point #1: Credit cards are more convenient -- that's why I like them. Think about all you buy in a day -- food, gas, clothes, etc. And imagine if you're on a business trip -- airfare, rental car, hotel, etc. If you had to carry enough cash to cover all of these, it would be a REAL hassle (not to mention a potential security issue.) I would agree that cash would probably make you spend less in these cases, but not because you'd want to spend less -- it might be that you actually want to buy something (maybe as simple as a lunch) and can't get it because you don't have enough cash on hand. Some readers will say "See! You admit it!" What I say is that carrying only cash is an inconvenience I can't afford, and even if I do end up spending more (which I'm not saying I do), it's worth it in time and frustration savings.
- Point #2: There's no difference between a credit card and a debit card regarding convenience, so the "debit card is better than a credit card" debate is dead. For people who pay off their credit card every month (which is one of my requirements for carrying a card), there’s really no meaningful difference between a credit card and a debit card.
- Point #3: You'll make more impulse purchases with a credit card. Maybe, maybe not. But if you want something and can afford it (meaning you pay it off every month), who's to say you can't or shouldn't buy it?
- Point #4: Just because the averages spend more, doesn't mean I do (or that a ton of other people do as well.) The averages have a zero savings rate. The averages make a lower income than I'd like. The averages have a paltry net worth. I don't have to settle for (or be locked into -- however you want to look at this) the averages -- and I refuse to be. I manage my money, my credit, my investments, and so on -- they don't manage me.
That's enough for now. There are probably a few points I missed, but this post is getting too long already. It's time to hear what you think. What's your take on this issue?