I've been fortunate never to have fallen down the hole of credit card debt. For those that have, it's a very difficult situation since lenders, of all types, make more money the longer you're in debt. Credit card debt is especially dangerous because it's so easy to accumulate and the interest rates are so high. Consider the hoops you need to jump through for a mortgage, which is backed by an actual home, and the requirements of a credit card seem almost comical.
When experts recommend debtors go cash only, I think it’s prudent advice. I think it’s important to recognize your weaknesses and only do things that improve your life. If you can’t use a credit card without falling into debt and paying double digit interest rates, don’t use them.
The unfortunate downside of cash only is that you subsidize credit card users. You pay for my rewards. I’ve believed this for years but until a recent Federal Reserve Bank of Boston paper, I didn’t have hard data to cite. Here’s the report but the gist is quite simple – cash only consumers subsidize credit card consumers because of higher prices. Specifically, a cash-using household pays $151 to card-using households and each card-using household receives $1,482 a year (that’s about half the average tax refund for 2009).
How does this happen? A merchant has no idea if a customer is going to be paying with credit cards or cash so he or she has to mark everything up by the extra fees a credit card transaction would charge. When you pay cash, the merchant is happier because they keep the difference. When I pay with credit, that fee is already included in the price of the item. The difference is that with the higher fee I also get credit card rewards, which offset the additional, albeit invisible, cost.
Unfortunately, going cash only is a must if you know you’re irresponsible with credit. I think it’s a prudent financial decision, but it’s also important to recognize that you’re paying more for the people who do use credit. So if you’re anti-credit cards for some other reason, just remember you’re subsidizing the rewards of others.
Why Credit Cards Offers Rewards
Trent responded to a reader the other day about the real scoop on credit cards and, while the premise was correct in that if you carry a balance then the rewards on a card don’t matter, his logic was flawed. While he doesn’t come out and say that credit cards offer you rewards because they expect you to carry a balance (he sort of just says that Americans are badly in debt and those in debt are more likely to be in more debt and credit card companies want to leverage that) but that’s actually not why they offer you rewards, it’s merely a benefit that comes with a positive expected value.
The real reason why credit cards offer rewards is because they’re paying you less than what the merchant is paying them in order to process the credit card transaction. Everytime you charge something, several companies take a piece of the action and the merchant getes somewhere in the neighborhood of 3% off the top. In order to entice you to put their card in your wallet, they offer to kick back some of it to you as 1% cashback. Many consumers don’t know this and now all those “no charging to credit cards unless the purchase is over $10″ signs and the lack of Discover/American Express acceptance probably makes more sense now (Discover and AMEX have the highest fees).
Here’s another sneaky tactic since we’re on the subject. Some card issuers offer reward points such as 1 point for every $100 spent. If you can convert that point into a
So, credit cards aren’t depending on you getting in debt but they certainly don’t mind it one bit.
