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What's the real deal with credit cards?

by Stephen Martiros

Last week, Jeanne Thompson and I hosted a virtual budgeting workshop with about fifty young employees at Dell Computer (shout out to Dell employee Nicole Edwards, a recent Babson grad, former Kindros intern, and organizer of the Dell budgeting workshop).

We received a lot of questions but the one that really stood out, that many people had was “What’s the REAL deal with cards?”

During our call, a young woman asked how many credit cards people should have. Both Jeanne and I blurted out the same answer at the time: “Only one.”

This got me thinking about why credit cards can be so alluring.

I’ve always believed that people spend more when paying with a credit card than using cash, a check, or a debit card. I also thought that reward cards end up costing people more in the end than the value of the rewards. So, I did some research and found several excellent studies on the topic. As it turns out, I was only partially right. Overall, people do spend more using credit cards.

An MIT Sloan School of Management and University of Utah[i] study “found that credit cards sensitize reward networks in the brain. They drive greater purchasing by acting to step on the gas.” The study also highlighted how “credit cards motivate spending by exploiting reward networks in the brain, which may become sensitized through reinforcement and conditioning processes.”

But it turns out that reward cards can provide real benefits but only for certain consumers.

According to a recent study by the Board of Governors of the Federal Reserve System,[ii] “super-prime and prime consumers (based on their higher FICO scores) spend more money and thus earn higher rewards, but they also pay back their balances in time and, therefore incur lower interest payments.”

Conversely, the study found “sub-prime and near-prime consumers (based on their lower FICO scores) earn lower rewards and incur higher interest payments due to higher outstanding balances on reward cards.”

This study illustrates that using credit cards triggers a feedback loop that may cause people to overspend. So, while rewards cards can provide overall value, they are primarily for people with high credit scores.

The average credit card interest rate has jumped from approximately 12.9% to over 22.8% since 2013. So, if you don’t pay off your credit card each month, your interest charges really add up!

Below are seven tips for using credit cards:

  1. Keep it simple and have only one credit card.

  2. Before making a major purchase, pause for a few minutes before completing the transaction to make sure you won’t regret it later.

  3. Don’t be tempted to sign up for an extra credit card just to get a discount on a one-time purchase.

  4. Use a reward card, but don’t chase the rewards by spending more than usual.

  5. Pay off your credit card in full each month if possible.

  6. Set up auto-pay for your credit card; this will ensure your bill is always paid on time, help improve your credit score, and minimize the interest you’ll pay.

  7. Finally, pay close attention to the interest rate on your credit card. The average interest rate consumers pay has skyrocketed.

[i] Banker, S., Dunfield, D., Huang, A. et al. Neural mechanisms of credit card spending. Sci Rep 11, 4070 (2021).

 [ii] Agarwal, Sumit, Andrea Presbitero, Andr´e F. Silva, and Carlo Wix (2023). “Who Pays For Your Rewards? Redistribution in the Credit Card Market,” Finance and Economics Discussion Series 2023-007. Washington: Board of Governors of the Federal Reserve System.


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