Paying with plastic
Pros and cons
There is an inescapable truth about credit cards. Paying with plastic changes the way we spend money. It alters the calculus of our financial decisions. Buying something with cash involves an actual, visceral loss. We feel that loss. Credit cards have the opposite effect. They reduce the pain of payment.
I have commented in the past about financial literacy and, right now, as Canadian personal and household debt continues to rise, I wanted to offer my observations about the sensible use of credit cards. First, some statistics.
Fewer credit cards, higher balances
CBC News reported1, in an online article posted March 8, 2017, that Canadians are carrying fewer credit cards, but maintaining higher balances. This is according to a new study released last year by TransUnion, a well known credit reporting agency headquartered in Burlington, Ontario.
They reported, and I quote, that ‘the number of open and active credit cards in use by Canadians declined by more than 800,000 in 2016. There were 43.4 million active credit cards in Canada at the end the year of last year, down from 44.2 million at the close of 2015.’
Despite Canadians carrying fewer credit cards, the average card balance per user rose 2.3% to $4,094 in the last three months of last year from a year earlier. More Canadians are also actively using card credit, resulting in an increase in total outstanding balances of 3.3% in the last year, from $91.2 billion in the fourth quarter of 2015 to $94.2 billion in the fourth quarter of 2016.
Delinquency
Delinquency is up, too. Delinquency rates rose ‘modestly’ year-over-year for each quarter of 2016, TransUnion reported, with the ratio of balances at least 90 days past due standing at 4.21% for the whole country over the last three months of 2016, up from 4.08% a year earlier.
The provincial pattern
The rise in delinquency is, according to TansUnion, ‘due to conditions in the hard-hit oil patch provinces, as both Alberta and Saskatchewan saw their delinquency rates climb by more than 22%. Meanwhile, delinquency rates in British Columbia and Ontario dropped by 2.1%and 3.3%, respectively.’
The overall national average balance for all non-mortgage debt rose to $21,912 at the end of last year, up just over two per cent from $21,444 at the conclusion of 2015. Over the same time frame, the delinquency rate for non-mortgage debt eased to 2.65 per cent from 2.7 per cent.
Credit cards, pro and con
While credit cards often get a bad reputation, the truth is that they can be a crucial financial tool if used responsibly. An article published by 360 degrees of Financial Literacy2, issued by the American Institute of CPAs, summarized some of the top advantages and disadvantages to consider before when using your credit card.
Advantages
- Convenience: Never worry about how much cash you have. Use a debit card instead. But if you use a credit card, pay off the balance in full each month.
- Recordkeeping: Your monthly statement records spending in detail. This is an invaluable resource to monitor your spending and when filing your taxes.
- Low-cost loans: Say you’re getting your salary cheque in five days, but there’s a purchase you need to make today. Charge your purchase now and pay off the charge after you get paid.
- Member perks: You can choose from a wide range of discounts or cash back based on your purchases. These savings add up.
- Reinforce your credit history: Using a line of credit by making purchases—and paying them off on time—will help you get and maintain a good credit rating from credit rating agencies.
- Purchase protection: Your credit card may step in to help if you want to dispute a charge or return a defective product. That’s a huge advantage.
Disadvantages
- Temptation: Credit cards are so easy to use they also make it easy to overspend.
- Interest charges: When you make a purchase and don’t pay it off at month end, you will pay both the purchase price but also the interest charge on that item. Big mistake.
- Fees: Some prestige credit cards charge annual fees. A basic utilitarian card lets you avoid this expense. Make sure the benefits of the card you carry outweigh the costs.
- Scammers: Credit cards are a prime target for scammers. Check your statement carefully. Report a suspicious charge immediately.
- Teaser rates: If a rate sounds fishy, it probably is. Beware temporary teaser rates.
- Conclusion: People spend money ‘til it hurts
Don’t let anyone persuade you that credit cards don’t incentivize you to spend more money. They do. Even among financial sophisticated, well-heeled consumers, they can have that effect. According to a 2007 study, researchers at Carnegie Mellon, Stanford and MIT3, found that people spend money ’til it hurts.
That study appeared in the journal Neuron and offers important insight from the emerging field of neuroeconomics, which looks at the mental processes that drive economic decision-making. The researchers suspect their study may help to explain why people spend more with credit cards than with cash.
‘Credit cards effectively anesthetize the pain of paying,’ said George Loewenstein, Carnegie Mellon professor of social and decision sciences (SDS) and co-author of the paper. ‘You swipe the card and it doesn’t feel like you’re giving anything up to make the purchase, unlike paying cash where you have to hand over bills.’
Perhaps the best advice is to heed that chorus line from the Rolling Stones: you can’t always get what you want, but sometimes not getting what you want is just what you need.
Geoff Funke, Senior Wealth Advisor, Scotia Wealth Management, 604.535.4721
1 http://www.cbc.ca/news/business/canada-credit-cards-transunion-1.4015250
2 https://www.360financialliteracy.org/Topics/Credit-and-Debt/Credit-Cards-and-Reports/Credit-Cards-The-Pros-and-Cons
3 https://www.cmu.edu/homepage/practical/2007/winter/spending-til-it-hurts.shtml