Credit card points and cashback can seem like free money, but they often mask the real cost of using credit. This week, we'll explore why those enticing rewards might not be as beneficial as you think, and how they can actually lead to overspending. Understanding the psychology behind credit card spending is the first step to taking control of your finances.
This week, you'll learn:
- How credit cards encourage overspending.
- Practical tips to avoid the credit card trap and stick to your budget.
Why do they offer points and rewards to begin with?
We've all seen the ads: "Earn double points on dining!" or "Cashback on all purchases!" Credit card rewards programs are designed to be enticing, and for good reason. They encourage spending! The more you use your card, the more rewards you earn. This incentivizes cardholders to make more purchases, even if they wouldn't have otherwise.
You can verify this yourself. Do an internet search for "why should I accept credit cards as a form of payment" You will see pretty quickly that one of the top reasons to accept a credit card is because it leads to larger purchases by consumers vs cash. On average 12-18% more is spent when using credit.
Think about it: when you pay with cash, you physically hand over the money. It's a tangible transaction that makes you more aware of how much you're spending. Credit cards, on the other hand, create a disconnect between spending and paying. That little swipe or tap doesn't feel like you're actually parting with your hard-earned cash. This psychological distance makes it easier to overspend and the credit card companies know it!
The credit card companies are in the business of making money. Offering rewards makes them more money, and likely costing you more money than the rewards you are earning.
According to a study by Dun & Bradstreet, people spend 12-18% more when using credit cards versus cash.
Let's break down some numbers...
Mr. Smith uses his credit card for all of his purchases of $3000 per month so he can earn 3% cashback. Mr. Smith overspends on average only 10%.
$3000 x 12 Months = $36,000 spent each year on a credit card
3% cashback per year = $1,080 ($36,000 x 3%)
10% overspending = $3,600 ($36,000 x 10%)
When you break down these numbers you will see that Mr. Smith is overspending $3,600 per year in order to receive $1,080 per year in cash back rewards.
It doesnt sound so amazing now does it?
Interest charges and annual fees make it even worse
Carrying a balance and paying interest on a credit card can significantly diminish the value of any rewards or cashback earned. Same with annual fees, which is some cases can be hundreds of dollars per year.
Here's why:
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Interest eats into rewards: The interest you accrue on a balance can quickly outweigh the value of any rewards earned. For example, if you earn 2% cashback on a $1,000 purchase, you'll get $20 back. But if you carry a balance and pay 18% interest, you'll end up paying more than $20 in interest, effectively wiping out the reward.
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High interest rates and fees: Rewards credit cards often have higher interest rates and annual fees than cards with lower or no annual fees. This means that carrying a balance on a rewards card can be more expensive than carrying a balance on a different type of card.
According to a new Bankrate survey, 44 percent of credit cardholders carry debt from month to month. Yet 67 percent of Americans with credit card debt still try to maximize credit card rewards.
Steps you can take to keep your credit card use in check:
Track your spending
- Print out the last 3-6 months of you credit card statments. Highlight all of the non essential spending and areas you may have overspent.
- When using a credit card be mindful of your purchase. Are you throwing something in your basket because it's on the card?
- Really look at your spending and determine if those rewards are worth it.
Use Cash
- Consider using cash for your everyday purchases to be more aware of your spending.
- This one thing can radically change your money mindset. You may be amazed at how much less you spend when you have to hand over the cash vs swiping a card.
