Ahh… reward points. That term sounds so nice, doesn’t it? Rewards are something we get for good behavior, for accomplishing a goal, for a heroic deed.
Credit card companies have come up with all kinds of ways to incentivize us to use their services. They provide cards with frequent flier miles, cash back bonuses, exclusive offers… reward points. “We love our customers so much we want to give away free money”, they say. Uh… right.
It’s a simple, effective strategy. They play the averages, kind of like insurance companies. The more customers they can lure in, the more people (overall) will be borrowing their money. Some people will spend way more in interest and late fees than they ever reap in rewards, depending on how disciplined they are. But for the rest (who understand how it works) there’s money left on the table.
This is where folks like you and me come in, am I right? To reap the benefits of this system?
Gaming The System
Credit card companies make money when we, the consumers, actually use the credit they offer. Like a payday loan service, they can charge interest rates that make the cost of that credit astronomically high. It takes forever to pay them off!
But for those of us with our finances (and spending habits) in better shape, these rules don’t apply! We are able to use the credit card companies’ services for free, as long as we find the right card and pay the balance off every month. Almost like a home equity line of credit, there’s money there if we need it. It’s free flexibility and free emergency coverage.
When you add reward points on top of that equation, it’s a fantastic way to get many benefits for free! You just need to do all your shopping with your rewards card and pay your balance off (in full) every month. It’s like the credit card company is giving away free money.
So why, at age 31, did I decide to stop using credit cards, when I was making “free money” through the rewards programs?
The Psychology Of Credit Cards
Credit cards really do offer flexibility. They really do give rewards, some of them very nice! The question I put to you (and I asked myself) is not about the credit card companies or their rewards programs, but about our own spending habits. Do credit cards incentivize me to spend money that I wouldn’t otherwise? Does the 1% cash back come even close to covering my extra spending, since I feel like I have more money than I actually do?
For example, Drazen Prelec and Duncan Simester reported studies on this topic in a 2001 issue of Marketing Letters. In one study, they told that randomly selected participants in the study would be offered the opportunity to purchase tickets to an actual professional basketball game that had just sold out. These tickets were highly desirable. Participants were told either that they would have to pay in cash or that they would have to pay by credit card. They were asked how much they would be willing to pay for these tickets. Those who were told they would have to pay by credit card were willing to pay over twice as much on average as those who were told that they would have to pay by cash.
That’s a HUGE difference in the level of willingness to spend. In our minds we don’t “feel” the impact like we do with cash.
Their point is that when we carry a credit card as our primary means of spending money, we do tend to spend more. From what I’ve seen, this is the case even when trying to stick to a budget or curb our spending habits.
When you leave a tip at a restaurant are you more likely to leave a larger tip with [a] cash from your pocket or [b] a number quickly jotted down on the receipt after a credit card purchase? When you grab that extra danish at Starbucks, do you feel any impact when paying with a credit card?
I think those small decisions can make a big difference over the short and the long haul.
When I first started using credit cards 12 years ago, those were my thoughts. “Another way to make a buck” I thought. “I’ll make $300/year just by spending normally.” And I wasn’t dreaming– it really does work the way I thought it would.
But that wasn’t the whole story for me.
In the fall of 2012 I realized that my budget wasn’t working properly. My spending was creeping into the danger zone.
The rewards points were nice, but I found myself making impulse buying decisions that I never would have made carrying cash. Ordering stuff online is so easy, especially when I find it on Slickdeals or Woot or 1Saleaday, and it’s on sale right now! And at never-before-seen prices!
I needed restraint more than I needed rewards.
As I’ve said before, I think I have a pretty good handle on my budget now, but my spending was being dramatically affected by using a credit card. Over the years I’d gotten comfortable with “floating” purchases into the next month’s budget (since the transactions wouldn’t actually hit my budget until then, after paying off the card balance). For me, having that delay after purchasing blurred the lines that should have been there to control mine and my family’s spending. If we went over in a category it didn’t seem like that big of a deal, because “we’ll handle it somehow”. I know that mindset can very quickly snowball into debt, and I decided that I had to do something about it.
My wife and I talked through some things and we decided to begin using our debit cards only, and totally take the credit cards out of circulation. It was painful! Whereas before we always “had the money” to pay off the credit card every month, we were technically spending money we wouldn’t even be making until next month! Well that’s no good. We paid off the credit card (bringing our bank account balance to around $300), and then began saving up a cushion so that we were living on last month’s income instead of next month’s expected income.
This change also impacted our buying behavior. Once I knew that the actual amount I was spending was coming straight out of my bank account, immediately, it made me much more cognizant of the small transactions that I was making. I no longer find myself saying “I’ll find a place for that.” Having to mentally categorize every transaction before I make it now keeps me much more on top of our finances.
Now I’m not saying that “the house always wins” or anything like that, because for sure I was pulling more money out of my Chase rewards card than I was sending in. But the side effects were hurting us, and that’s what prompted the change.
Are Debit Cards Closer to Credit Cards Or Cash?
I’d love to get feedback from any of you who have gone through this, because I don’t know! By switching to debit cards as our primary purchasing methods, my wife and I have had a much easier time understanding where we stand with our budget, knowing where the limits really are, and communicating with each other regarding money. It’s not the same as using cash (I still find myself leaving overly-large tips when eating out) but debit cards are waaaay more convenient, both for the act of purchasing something and the tracking on the back end. So we’re content for the time being. In my mind they are the best option available in our modern economy, but I know some folks who swear by cash and simply deal with the inconveniences.
I’ve also read several blogs recently talking about churning credit cards but I can’t help thinking that there’s still going to be a price to pay down the line. Sometimes we can’t afford free.