You don’t have to be a Federal Reserve researcher to understand that credit card rewards successfully entice people to spend more than they should.
Recently, researchers at the Federal Reserve Bank of Chicago took the time to report just that — releasing a study explaining exactly how much more people spend and how that increased spending affects personal debt.
While the focus of the report, that rewards credit cards lead to more spending and more debt, may seem like a no-brainer, this kind of research is good for demonstrating this truth to naysayers.
This kind of work is a breath of fresh air for us at PerkStreet, because we actually find that super budgeters are often the most vocal in their praise for our rewards debit cards. Why the difference? Debit cards force you to spend money you actually have the moment you make a purchase — a fundamental we believe is key to successful budgeting because it’s closely linked to the way money evolved historically. On the other hand, credit cards separate the pain of spending from the excitement of getting something new.
Take this recent quote from a New York Times executive for example:
“We have north of 800,000 subscribers paying north of $700 a year for home delivery. Of course, they don’t seem to know that,” said Gerald Marzorati, the assistant managing editor for strategic initiatives at The New York Times Company on a recent panel. Marzorati went on to report that when the paper raised its rates by 5 percent during the recession, only 0.01 percent of subscribers canceled. ”I think a lot of it has to do with the fact that they’re literally not understanding what they’re paying,” he said. “That’s the beauty of the credit card.”
You spend money with a debit card and that money is gone from your account. There’s no “surprise” bill arriving later. PerkStreet makes it less painful for our customers by paying out big rewards, not by distracting you from the truth. Unfortunately, it would seem this is a key difference between debit cards and credit cards.
The report, which is based on data from 12,000 actual credit card accounts under monthly examination from 2000 to 2002, reveals that the addition of a 1% cash rewards program resulted in — you guessed it PerkStreet customers, an average of $25 in rewards each month. (That’s half of what we report the average American family could earn with PerkStreet’s 2% cash back program.) The catch was enough to raise eyebrows, however:
The research showed this credit card rewards program led to an increase in spending of $68 a month and a jump in credit card debt of $115 a month.
Credit cards that reward just half of what PerkStreet’s debit cards offer result in people owing more than four times as much to the credit card company as they’re earning in rewards.
Let this be a lesson to those out there who think they’re above the system that credit cards operate under: Credit cards are designed to get you and optimized to trap you based on tactics credit card issuers know work.
Perhaps the most shocking finding in the report will jolt those of you out there who still aren’t convinced. “Cardholders with higher credit limits tend to spend more and accumulate more debt per month on average in response to the cash-back program,” note the authors, Sumit Agarwal, Sujit Chakravorti, and Anna Lunn.
“Cardholders utilizing less than 50% utilization of their credit limits tend to spend more and accumulate more debt per month.”
How does this translate in layman’s terms?
People who don’t have a problem with debt before enrolling in a cash-back credit card rewards program tend to accrue more debt afterward. This indicates that credit card rewards actually entice smart spenders into debt, though many of the same smart spenders would likely assume that the temptation of credit card rewards wouldn’t impact those in their peer group.
If you think you can outsmart the system, think again.