The American Way

What does it mean to be a U.S. citizen? Understanding the American psyche.

Why We Overspend With Credit

Both emotional and cognitive forces stimulate overspending with credit.

When used responsibly, credit cards are a valuable financial instrument. They are generally more convenient to carry and use than cash, and they allow consumers to “smooth” consumption over time (borrow from the future during lean times to maintain a constant standard of living).

However, credit cards can be dangerous for a number of psychological reasons. As discussed in a previous post, the urge to pursue goals closest to completion drives people to focus on repaying small debts first, regardless of interest rates, potentially leaving money on the table.

Experimental research also suggests that credit cards can stimulate overspending: People are often willing to pay more for the same product when using credit than when using cash. Certainly, outside the lab, there are many trait-based explanations for such a “credit card premium” – for example, people who choose to use credit may differ fundamentally from people who choose to use cash. However, even when usage of cash or credit is randomly assigned in experimental settings, people tend to spend more with credit.

The credit card premium is consistently observed because there are a number of psychological forces that underlie it. For example, it is less psychologically painful to swipe a credit card than to physically hand over cash. Manoj Thomas and colleagues recently found that spending differences between tightwads (who chronically find spending painful) and spendthrifts (who don’t find spending painful enough) were smaller when people were required to use credit to make purchases than when people were required to use cash. Credit helps to anesthetize the pain of paying, and it caused tightwads to nearly catch up to the spending levels of spendthrifts.

Credit not only helps to reduce the sting of payment, but there is some evidence that it also stimulates desire. In a series of experiments in the 1980s, Richard Feinberg manipulated whether or not credit card logos were visible while participants contemplated how much they would be willing to pay (in cash) for several products. Feinberg found that hypothetical willingness to pay and actual cash donations to charity were significantly greater when credit card logos were visible than when they were not. (These surprising findings were replicated two decades later by Priya Raghubir and Joydeep Srivastava.) The results suggest that consumers have been conditioned to associate credit card logos with consumption. Exposure to credit card logos may therefore stimulate craving, much like smelling fresh cookies stimulates hunger.

In addition to these emotional factors, cognitive factors can also contribute to the credit card premium. Credit limits, in particular, can give credit users benchmarks against which to compare prices. Research by Dilip Soman and Amar Cheema suggests that high credit limits can signal future earnings potential (at least among consumers with limited credit experience), and these expected earnings can make prices seem relatively small, which in turn stimulates spending. Work by Carey Morewedge and colleagues raises the possibility that credit limits themselves, when salient, help to make purchases appear small (for example, a $1 candy bar may seem less expensive when compared to $5,000 in available credit than when compared to the $5 bill in one’s wallet).

Because credit limits may be easier to recall than the exact balance one is carrying at the moment, credit cards that communicate the balance to users could prove helpful (for example, a light card that gets increasingly dark as the outstanding balance increases). Users with high balances get the unavoidable reminder and perhaps fear the social stigma that comes with using a visually maxed-out card. Of course, lenders may be less than eager to provide such a card. And even if they were to provide such a card, other factors discussed above (like increased craving) could still encourage overspending. People who routinely use credit and repay their balance in full every month probably have little to worry about, but people who alternate between cash and credit, or who carry credit card debt, are most likely to be affected. At the very least, these results serve as a reminder that the extent to which we value goods should be independent of how we pay for them. Being mindful of the biasing effects of credit may help to curb overspending.

The American Way