The Irrational Use of Credit Cards
Our irrationality toward money and inability to fully visualise the impact of distant events is how credit card companies thrive and many bank balances suffer.
That’s the conclusion one draws after reading this article from Time that looks at a number of studies showing that we fail miserably in making logical decisions about money when we use credit cards rather than cash.
As a species we’re just really bad at understanding costs that come later on. Instead, we assign a disproportionate amount of importance to what’s immediate and tangible. […]
Once we’ve got our card in hand, our behavior becomes riddled with irrationalities. In one experiment, Drazen Prelec and Duncan Simester of the Massachusetts Institute of Technology found that people were willing to pay twice as much for basketball tickets when they were using a credit card as opposed to paying cash. Credit-card spending just doesn’t feel like real money. In another study, Nicholas Souleles of the University of Pennsylvania and David Gross of the consultancy Compass Lexecon calculated that the typical consumer unnecessarily spends $200 a year in interest payments by keeping a sizable stash of cash in savings or checking while at the same time carrying a credit-card balance. In our heads, the two don’t line up.
2 Comments
I think both the article and the media assume that people doing this are irrational.
The UK government at least has made it remarkably easy to rack up huge debts on secured and unsecured loans, declare yourself bankrupt with an IVA, stay in the house that you overborrowed (and then secured additional loans against) to buy and have your credit record wiped clean after only a couple of years. No nasty reposessions, no nasty bailiffs, no repercussions in fact.
Therefore I’d say that treating your credit card as a magic never-never fountain of money is quite rational in the current political climate of bailing out those people who have taken fullest advantage of cheap credit with public money.
And the fact that credit card companies expend huge resources on exploiting this behaviour doesn’t help us in making the right choice—rational or not.