Spending psychology: When should you stop using your credit card and pay cash instead?
You may be overspending because of the payment method you choose, experts reveal
Dubai: When you’re seeking to control excessive spending or mounting credit card debt, financial therapists or money coaches often suggest first thinking about how you interact with money at a rudimentary level, like when it comes to using credit cards instead of cash.
One negative aspect that’s often pointed out when it comes to becoming increasingly dependent on your credit card for everyday spending is that it sometimes can feel like you aren't spending real money, as opposed to when you use cash instead or swipe your debit card.
Also, an increasing number of academic research worldwide show consumers who pay with a credit card focus on the benefits of a purchase, while those who pay with cash look at its cost. Here’s a look at the thought process behind using both, and how the mindset can lead to unintentional spending.
The ‘credit card premium’ phenomenon arises as a result of an emotional pain associated with handing over hard currency that curbs spending
Do you focus on benefits or the cost of a purchase?
When it comes to credit cards, it's well established in the field of behavioral economics that people who use plastic are unconsciously willing to spend more than those who pay with cash, a phenomenon known as the ‘credit card premium’.
“The ‘credit card premium’ phenomenon arises as a result of an emotional pain associated with handing over hard currency that curbs spending, as opposed to mindless purchasing when handing over the plastic card instead,” explained Matthew Griffin, a UK-based behavioural economist.
“It provides a lesson for even financially prudent people — just because you pay off your card balances every month to avoid finance charges doesn't mean credit cards aren't harming you. You might be overspending, simply because of the payment method you choose.”
Studies show link between card use, higher spending
Several studies into consumer spending conducted by world renowned universities like US-based Massachusetts Institute of Technology, Harvard and UK’s University of Oxford have shown a clear link between credit use and increased spending. One of the more famous studies comes from MIT.
Business professors at MIT, Drazen Pralec and Duncan Simester, set up an auction for tickets to desirable sporting events, with participants restricted to using either cash or a credit card to bid on the tickets. The study showed those using credit were willing to pay twice as much as cash buyers.
Other spending surveys analysing shopping habits globally found greater disparities between cash and non-cash payments, with the average cash transaction value ranging between $20 (Dh75) to $30 (Dh110), while the average non-cash transaction was between $110 (Dh400) and $120 (Dh450).
It provides a lesson for even financially prudent people — just because you pay off your card balances every month to avoid finance charges doesn't mean credit cards aren't harming you
Why else do people spend more with credit cards?
These studies also infer another reason why people spend more with credit cards: The intention to pay with cash or credit can determine whether he or she focusses on a product's benefits or its cost — to the point they might choose different products when they know they will be paying with credit.
"When we are exposed to new products and thinking about paying with credit, we tend to focus on the good things about the product — the aesthetics of it, the features that are better than other products we’re considering, the luxury of it etc.," added Griffin.
"That's as opposed to details like price, shipping cost, warranty cost, installation cost and effort. At times, the pleasantness experienced when making a purchase are disconnected from the unpleasantness of making the payment upon receiving the credit card bill. That disconnect can lead to overspending on credit if we don't have to face any financial consequences until later.”
Are you overspending using your credit card?
Griffin further added that given this challenge, knowing when one needs to stop using his or her credit card is vital. When a couple of UAE residents were asked if they’ve noticed their spending increasing when using their credit cards as opposed to cash, there were mixed responses.
Dubai engineer Jeremy Davies, 36, agreed he tends to go overboard when spending with his credit card, and has switched to predominantly using cash since, but Sharjah-based real estate broker Jaimy Thekkethu denied spending more on credit as she uses a mix of credit and debit cards or cash.
“I don’t use my credit card for all my transactions so as to keep my spending in check. I also don’t want to miss out on the perks my credit cards offer me, so I use them judiciously and keep cash handy for quick purchases,” Jaimy added.
While I don’t use my credit card for all my transactions, I also don’t want to miss out on the perks my credit cards offer me, so I use them judiciously
Key takeaways
When you use your credit card, you may notice it feels different than when you hand over cash to make your purchase, as opposed to when you swipe plastic and it may not feel like you’re spending real money at all. This gives way to the phenomenon, the ‘credit card premium’.
Credit card premium’ turns out to be a pretty common feeling, as research shows that people are more likely to overspend when they’re paying with a credit card instead of cash. When Griffin was asked why this was the case, here’s how he put it.
“One reason could be using cash to make your purchases is a much more transparent process than using credit. You have to take money out of your wallet and hand it to another person. You see the amount you have in your wallet decrease, and the weight of that transaction takes a toll,” he said.
“On the other hand, when you’re paying with a credit card, you’re essentially kicking the can down the road. You might not notice your card balance at the time of purchase, and you don’t pay your bill until the end of the month.”
So when it comes to paying for things, it may not be as simple as ‘Is it better to pay cash or a credit card?’
“However, being aware of the behavioral tendencies, particularly when it comes to individual spending patterns can help you spend wisely and balance using a credit card and cash appropriately,” added Griffin.