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Are You Anti-Credit Card? If So, You’re Putting Money in Plastic Lovers’ Pockets

Cash Users Indebted Consumers Subsidize Plastic
There are many reasons why using a credit card is a good idea.  To be fair, there are also a number of reasons why it might not be, but I bet you didn’t know that by using cash you’re basically subsidizing the expenses of plastic-wielding consumers.

Consumer Cost Sharing Inequities

Who Gains and Who Loses from Credit Card Payments?

A 2010 study from a trio of economists at the Federal Reserve Bank of Boston found that the average plastic-friendly household receives a $240 annual subsidy from cash users.  The root cause:  Merchants typically don’t increase prices for card-based transactions, which means those who use cash share part of the financial burden for both credit processing and rewards programs yet receive none of the benefits.

Scott Schuh - Federal Reserve Bank of Boston

If you just think about any person that walks into a store with cash and makes a payment and then another person follows with a credit card and makes a payment, then in that situation the average price of the product that the two people bought would experience this transfer at the point of sale between the cash user and the card user,” says Scott Schuh, director of the Boston Fed’s Consumer Payments Research Center and one of the economists who produced the aforementioned 2010 study titled, “Who Gains and Who Loses From Credit Card Payments.”  “It makes perfectly good sense for [consumers] from a personal finance perspective to use their credit card wisely by putting as many payments on it as possible, paying off the balances every month, and reaping the rewards.

New Surcharge Rules Won’t Change Much

New rules that allow merchants to assess surcharges on transactions paid for with plastic are unlikely to affect this unique dynamic much either.  Basically, just because they can assess a surcharge doesn’t mean they will.  You see, merchants have to consider the distinct possibility of alienating customers during uncertain economic times, not to mention navigate a minefield of conflicting card network rules.  Ten states also have laws forbidding credit card surcharges.  It’s therefore far more likely that merchants will use the threat of surcharges to attempt to renegotiate the fees that card issuers charge them than they are to actually take aim at customers’ wallets and pull the trigger on new fees.

“Conceptually, if merchants choose to surcharge their credit card customers, that would likely reduce the transfer between cash and credit card users,” Schuh notes.  “I wouldn’t want to speculate about what actually might happen, but I think if merchants do begin to seriously discount or surcharge payment methods that it is a very important, interesting, and open question as to how consumers, banks, and merchants might respond to that.  It’s a big unknown right now, but I think the one thing an economist would say is that if the pricing changes, or if the information structure changes, then it’s likely to have some effect.”

More Subsidies for Plastic Users

It’s also important to note that cash users covering credit card costs isn’t the only cost-to-value disparity in play here either.  Indebted card users also wind up paying a premium in the grand scheme of things.  According to the study, people with unpaid revolving debt “pay a transfer of $511” to debt-free card users.  You see, issuers help pay for their overall expenses with finance charges.

When you further consider that credit card users tend to be wealthier than non-card users, interest rates are highest for people with below-average credit (who also trend toward lower income levels), and your likelihood of incurring debt increases as your income decreases, we end up with a regressive landscape in which the average household that makes $20,000 or less per year pays $63 toward credit account perks, while those making $150,000 or more receive an $823 annual subsidy.

This, of course, begs the following obvious question:

Why doesn’t everyone use credit cards?

The primary reason would, of course, have to be the threat of debt and credit score damage.  A lot of folks simply don’t trust themselves to use credit responsibly, perhaps due to past negative expenses or simply the innate sense that they will inevitably overspend.  You can’t discount the influence of culture either.

Lars Perner - University of Southern California

Some people have had bad experiences, but [there are] also some people who believe more as a moral matter that debt is wrong,” said Dr. Lars Perner, an assistant professor of clinical marketing at the University of Southern California’s Marshall School of Business.  “This may have something to do with culture.  It turns out that in German and in Danish, the word for ‘to owe someone’ actually is the equivalent of ‘guilt,’ so you would actually say, ‘I guilt someone money.’  You [also] find out a number of Asian cultures have a very strong aversion to credit, so either from a personal experience or from a cultural value background, a lot of people will avoid that.

Dr. Perner also notes that cash users might not actually end up footing as much of the credit card community’s bills as the data initially seems to indicate.

“To the extent that people use credit cards, that may cause them to buy more than they otherwise would,” he says.  “As a result, the volume of sales would go up for the store so that the purchases that are sold on credit could actually be highly profitable because of economies of scale with volume.  It depends to some extent on the industry.  If you look, for example at the grocery industry, you have typically a gross margin of somewhere between 20 and 25%, but the net margin is in the low area that we’ve heard about, somewhere between 1.5 and 3%.  If you’re talking about a credit card surcharge of, in some case, one-and-three-quarters percent, that could wipe out half the net margin essentially, if you assume that people would have bought the same amount of merchandise with cash if they hadn’t had the opportunity to pay with credit cards.”

What this Means for You

The aforementioned findings are more than just interesting.  Depending on your perspective, they might also provide a clear impetus for improving your personal financial performance in order to maximize the benefit of credit card use.  I mean, do you honestly want to be paying your neighbor’s bills or booking rewards flights and the like on someone else’s dime?  In a perfect world, we’d all pay for only what we use, but that’s clearly not the way things work.

With that said, here are four tips for making sure you end up on the high side of the seesaw.

  1. Maximize Your Credit Standing:  Credit card companies offer the best rewards to consumers with excellent credit.  That means the spoils of card use – which are paid for in part by non-card users – won’t be available to you if your credit score isn’t up to snuff.  Plus, you can’t discount the fact that your credit score affects more than just the credit and loan terms for which you qualify.  It also has some bearing on your insurance premiums, job prospects, living situation, and transportation options.  Improving your credit standing will therefore have a universally positive impact on your finances.The best way to improve your credit is to manage a credit card account responsibly, as issuers report usage information to the major credit bureaus on a monthly basis, thereby helping you infuse positive information into your credit reports.  In order to avoid padding the pockets of those who already have high credit scores while you’re working toward that status, use a no annual fee credit card and pay your bill in full every single month.
  2. Feed an Emergency Fund:  This might seem to be a bit out of place, but it’s important that you establish an emergency fund before you can really focus on freeing yourself from debt.  If you lose your job or encounter a major unexpected expense and you don’t have some money stowed away for a rainy day, you’ll just find yourself up to your ears in unpaid balances even if you previously managed to pay off everything you owed.  The goal is to have about a year’s after-tax income in reserve, but you’re not going to accomplish that in one fell swoop, so deposit as much as you can comfortably afford each month until you get there.
  3. Get Debt Free:  Make no mistake about it, paying down amounts owed is a process – a wholly worthwhile one, yet a process nonetheless.  The best strategy has four parts:  1) Budget – Ensure that your monthly after-tax income outweighs your recurring expenses; 2) PlanUse a credit card calculator to develop a debt payoff plan and find the absolute best credit card on the market; 3) Island Approach – Get the best collection of terms by designating one credit card for revolving debt and other for making everyday purchases; 4) Debt Snowball – Attribute the majority of your allotted monthly debt payment to the balance with the highest interest rate while making minimum payments to all others, then repeat.  Check out Card Hub’s Financial Resolutions for 2013 for more about how to best approach your pesky balances.
  4.  Live Within Your Means:  We alluded to the importance of living within your means in the rationale for the previous tip, but it’s important enough to warrant elaboration.  You’re never going to escape debt if you spend more than you bring in each month.  That’s obvious.  However, it can be difficult to gauge whether you’re overspending or not when your ongoing expenses get jumbled up with ongoing debt.  Using one card specifically for ongoing expenses is really helpful in this regard, given that if finance charges ever show up on this account’s statement, you’ll have a clear reminder to cut back.
  5. Maximize Your Earning Potential:  The end goal here is to benefit as much as possible from your own money, not use it to pay for other people’s credit card rewards.  As mentioned previously, that necessitates having the best possible credit card and paying your bill in full every month.  Your income plays a big role in that since credit card underwriters evaluate both your credit standing and spending power when making approval decisions and it’s obviously easier to pay your bill when you have more money.  So look into some alternative revenue streams, pick up some new skills, or just market yourself better in order to boost that account balance.

At the end of the day, this advice is relevant to millions of consumers across the country.  About 30% of consumers do not have credit cards and we continue to rack up debt in record numbers.  So, the choice is yours:  make a change or continue to pay others’ bills.

Image: alexmillos/Shutterstock

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