If I give you $25 today will you spend $68 more per month for the next three months?
Sumit Agarwal, Sujit Chakravorti, and Anna Lunn of the The Federal Reserve Bank of Chicago published research that shows how cash-back credit card offers cause card holders to spend more, reduce payments on other card debt and increase total card debt.
First, a little history. According to the research:
- Six billion credit card offers were mailed to consumers in 2005 with a 0.3% response rate. The mailings are usually random to avoid trouble with bank regulators and discrimination claims.
- In 1970, credit card related consumer debt totaled $2 billion as compared to $626 billion in 2000.
The researchers found that, on average, a cardholder who got $25 in cash-back rewards increased spending by $68 per month and their average debt went up by over $115 per month in the first quarter after reward program started.
Credit card users moved most of their spending to the reward card and decreased payments on the other cards in their wallet. This is a financial rabbit trail that leads nowhere in the forest of debt.
If you had any doubt about the motives of credit card companies, the authors made the claim that the goal of the banks is to entice customers to spend more on their existing cards that could lead to a bigger carried balance and higher interest and fee income for the card issuer. This is a prime example of potential borrower tipping by banks to increase profits.
The Chicago Fed research referenced a key research paper (Ausubel, 1991) which finds that consumers often ignore the interest rate on credit cards because when they make purchases they fully intend to pay back but change their mind when the bill comes.
The study sums up the profit motives of credit card companies with the finding that rewards are an effective tool to steal customers from a financial institution’s competitors.
Can that be good for the consumer?
How can you protect yourself from the allure of cash back cards?
- Never carry a balance
- Spend less than you earn
- Make a budget and stick to it
- Do what you say that you’ll do
- Recognize the profit motives of all companies
- Admit you are over matched in the borrowing arena
- Get objective, qualified borrowing advice from a trusted advisor or borrowing coach
Are banks and credit card companies acting unfairly by prying as much cash from your wallet as possible? Join the discussion
- Rewards Cards Lead to More Debt (online.wsj.com)
- What No Pre-Set Spending Limit Really Means (applyforacreditcard.com)
- Banks and Cash Back Credit Cards (paul.kedrosky.com)
- Credit Card Habits to Avoid At All Times (applyforacreditcard.com)