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Credit cards can be a convenient way of accessing credit quickly whenever you need it - but they can be so much more than that. Because credit card providers make money by charging you interest when debt is carried over from one month the next, credit cards are 'designed' to encourage you remaining in debt for as long as possible. Here is how:
The average credit card limit is typically a multiple of one’s monthly income – and having easy access to a large amount of money can make it easy to treat these funds as your actual spending limit rather than an emergency fund. Credit card bills encourage this kind of thinking by highlighting your remaining available credit. The problem with having a large credit card limit is that once you use it, you may not be able to repay it back for quite a while. This is good for credit card providers, because they get to charge you interest along the way – and that can be a very long way.
High credit limits make purchases appear smaller – a £60 dinner for two might seem more affordable in the context of a £5,000 credit card limit rather than a £300 balance on your account. On top of that, £15 is spent easier with a plastic card than a £20 banknote. In fact, research shows that on average, people are willing to spend around 15% more when paying with a credit card. Think about it: when paying with cash, you are giving something away; when paying with a credit card, you’re not losing anything physically, and the expense becomes less noticeable.
Cash-back on your purchases is essentially rewarding you for spending money. This can encourage you to spend more easily, as getting something back feels rewarding, or at least less painful, than losing the entire fixed amount. And while getting 2% back from your credit card purchases can, in principle, save you money, you often end up paying more in interest charges than you will ever save from cash-back rewards unless you pay it back quickly. Thus, your cash-back rewards increase spending while shifting your attention away from the interest charges.
The minimum repayment is a small proportion of the total balance. The reason for this is the anchoring effect: the amount presented sets a cognitive ‘anchor’ on what you should actually pay back. When faced with a £5,000 debt, paying back £100 seems rather hopeless – but when faced with a £5,000 debt and a £25 minimum repayment, paying back £100 can seem more than satisfactory. This way, having a low minimum repayment can make you repay less and end up paying more in interest – and many of us tend to underestimate how quickly interest compounds over time. It is for this reason that in 2018 the FCA brought in new rules to make credit card companies encourage customers to pay back more than the minimum payment to try to help avoid people remaining in persistent debt.
Credit cards shift attention to how much credit is still available instead of how much interest you pay for your debt. This is reflected in how the product is designed: available credit is clear and easy to check, while interest rates and charges tend to operate according to a complex set of rules that you either don’t really understand or quickly forget. Moreover, many credit cards offer limited-time benefits or interest-free initial periods that are just long enough for you to develop a credit card habit and forget that the benefits don’t apply anymore.
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