Another research project indicates people do spend more with credit cards

A published study by researchers at Carnegie Mellon, Stanford and MIT, indicates that people  “spend money ’til it hurts”.   The study appears in the journal “Neuron” and is the most recent from the emerging field of neuroeconomics, which looks at the mental processes that drive economic decision-making.

However, before any of you credit card advocates start overdosing on your blood pressure medications, let me quickly assert that this study DID  NOT prove that people spend more with credit cards than with cash; it only gives credence to the theory.

“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.”

OK.  How exactly did the study work?

Remember that these people are, uh, brainy.

In the study, 26 adults were each given $20 to spend on a series of products that would be shipped to them. If they made no purchases, they would be able to keep the money.   The participants viewed the products while lying in a functional magnetic resonance imaging (fMRI) scanner while the researchers studied which regions of the brain activated during each participant’s decision-making process.

With the study participants all wired up, the researchers goal was to learn if their brains would register pain when they saw higher prices.  Guess what?  They did.

An electric moment

“We were so excited when we got the results from the first scans, and saw that the insula, a section of the brain associated with pain processing, activated when subjects saw prices that were too high,” said Loewenstein. “It was an electric moment.”

Scott Rick, the SDS graduate student who worked with Lowenstein on the project, was especially excited when they found that insula activation discouraged spending.

“It suggests that prices do not deter spending purely through thoughts of foregone pleasures, as assumed by standard economic theory, but also through immediate pain,” added Rick.

Restated in my words: “The findings indicate that people decide not to buy because they intrinsically know the purchase. while giving some pleasure, will also cause pain.  When the fear of pain overrides the anticipation of pleasure, people decide not to buy. ”

Loewenstein and Rick, along with Cynthia Cryder, also a graduate student in SDS, are continuing their research on the “pain of paying” — the pain one experiences when paying for purchases.

My thoughts

Far be it from me to second guess brainy researchers, but I think they overstated the results of the study.  While giving strong credence that the brain does register pain when prices are too high, Loewenstein took a leap in logic when he said that the study explains why people spend more with credit cards (less pain than cash).  The problem is that he never actually tested the pain using credit cards versus cash; he only proved there is more pain when prices go up.    I wish the researchers, while they had these 26 adults’ brains all wired up up, would have required them to pay cash and then swipe plastic for the same value purpose.  At least we might have been able to have learned if the credit card pain theory was valid.

In the meantime, I suppose we will have to wait for another study to actually prove whether people spend more with credit cards than with cash.

How about you?  Do you personally spend more using credit cards than using cash?  How do you know?

Make sure you read the fine print about minimum payments

photo credit: TheTruthAbout…

Question: Obviously, something was haywire, but what was it?

Answer: I didn’t understand how minimum payments are figured.

Explanation: The minimum payment decreases as the payoff amount decreases.

In the scenario I tried, the minimum payment was based on the interest owed for that month plus 1% of the payoff.  For the $5,000 debt, the interest for the month 1% (1/12 of 12%), or $50 and of course the 1% of the payoff is also $50 for a total minimum payment of $100 the first month.

The Minimum Credit Card Payment Strategy

Now: follow along with me, for this becomes a bit diabolical:  using this same formula (the interest plus 1% of the payoff), the minimum payment the following month becomes $99.  As the payoff becomes less, the minimum payment continues to likewise decrease, thus stretching the debt for years and years.  The 259 months (21 years and 7 months) is based on never borrowing any more money and never being late on a payment.  Of course either of these events will lengthen the payoff even more.

The calculator gives different choices for calculating a minimum payment, but they are all based on the same premise: the minimum payment decreases as the balance decreases, thus keeping the borrower in the grips of the credit card company for years more than needed.  I should point out that all credit card companies do not figure their minimum payments the same way.  This post at Credit Card Chaser answers the question, “How do credit card companies figure the minimum monthly payment?”

This chart compares various minimum payment plans with fixed rate payments.  All are based on $5000 debt and 12% interest rate.

Concluding Thoughts on Minimum Credit Card Payments

The numbers are obvious.  Do you want to be paying on that same credit card until your newborn is out of college?  Of course not.  This math is not rocket science, but it can be deceiving.  The more you pay, month in and month out, the quicker your principle will drop, the less interest you pay and the faster you can get rid of your debt.

Remember: your credit card company doesn’t want you to get your debt paid off.  The longer you drag it out, the more you end up paying and the greater risk of adding to the debt or being late on a payment.

Escape their tentacles by sacrificially making huge payments!  If you could bump that payment to $400 a month, the debt will be gone in only 14 months.  Get an extra job and pay $600 a month to see it disappear in only 9 months!  You will be able to breathe knowing that the debt has lost its grip on you.

And 9 months sure beats 259 months!

Readers: Do you make minimum payments on your credit cards?  Before reading this post, did you know how long it will take you to get your credit card debt paid off by making minimum payments?  Are you currently attacking your credit card debt?  If so, what are you doing that works?  That doesn’t work?

photo credit: TheTruthAbout…

The major changes required by the Credit Card Act of 2009 will kick in on February 22. But just because Congress has tried to stifle the less than stellar side of the credit card industry, don’t think for a moment that banks have been sitting on their heels.

Here’s how the new laws on credit cards of 2010 effect you.

First, an Overview of the Changes

• Limits on interest rate changes.

Increases on existing balances will be limited to some certain criteria: the cardholder is 60 days behind in minimum payments, a promotional rate has expired, or the card carries a variable rate. Hint: remember “variable rate”. We will come back to that one.

• Elimination of “universal default” and “double billing” cycles

These shady practices will be outlawed.

• More time to pay bills.

Card issuers are required to mail statements at least 21 days before they are due.

• Higher interest balances paid first.

When cardholders have accounts with different interest rates (common with 0% balance transfer credit card accounts), any amount above the minimum payment must go toward the highest interest rate (instead of the industry practice of using that extra money on lowest interest portion of the debt).

• Limits on over-limit fees.

Transactions that would place the card holder’s account over their limit cannot be processed without prior permission.

• Plain language disclosures

Card companies must state clearly how long it will take the card owner to pay off the balance – and the total interest charge – if minimum payments are made.

• Restricts credit to minors.

Card issuers must either verify ability to pay or obtain the signature of a parent or other adult before giving credit to anyone under 21 years old.

Now: What to watch for

• Rate hikes

“Whoa”, you say, “I thought the new law greatly limited rate hikes. I always pay on time, so how can my rates go up?”

Good question. Remember the phrase “variable rate”? The majority of card holders, even under the new changes, will experience rate hikes due to the variable rate clause. Here’s why: variable rates are meant to follow the rise and fall of the prime rate index. The problem is that the prime rate is currently 3.25%, an historic low. Therefore, when it changes, there is only one direction it will go: up. And so will credit card rates, which currently average 14.9%.

Of course the banks have been pushing variable rate cards. According to CNN Money, 94% of all new credit cards offered in recent months are variable credit, compared to only 67% in the same period two years ago. Admittedly, the prime hasn’t gone up in recent months, but stay on your toes. Your card is most likely a variable rate card, so when prime rate goes up, so will your rate.

• Establishing minimum rates

If you ran the bank and a new law greatly restricted your ability to raise credit card rates, you would not only promote the variable rate cards, but you would ensure that rates won’t fall below a set floor rate. The logic? “I want the rate hike when the prime goes up, but I don’t want the risk of lower rates.” Very clever, and that is exactly what banks are doing. A year ago, only 10% of banks had enacted such a floor, but a recent study shows over one-third of banks now have established minimum rates.

Unfair? Consumer groups are crying “Foul”, appealing to the Federal Reserve Board to rule against these floors, but no decisions have been made yet.

What should you do?

• First and foremost, don’t charge anything you can’t pay for. If you always pay your credit card bill in full, you don’t have to worry about rising rates.
• If you have outstanding credit card debt and a decent credit rating, check into switching cards. You can get an objective comparison at the credit card web site.
• Make a plan to get all of your credit card debt completely paid off. Make a budget, talk with your spouse and get focused.

Debt free is the way to go!

photo credit: xJasonRogersx

Credit card legislation and new Federal Reserve rules which passed last year are consumer friendly, but don’t expect credit card companies to make things easy for their customers. Some of the changes have already gone into effect, but the majority of the them will take effect on February 22, with more scheduled for this summer. As these deadlines close in, you can expect banks to step up efforts to seize advantages before the rules change. According to Adam Levin, co-founder and chairman of Credit.com, the banks’ philosophy toward their customers is, “It’s not our job to teach you the law; it’s our job to comply with the law.” Stated differently, they will keep the letter of the law while sidestepping the spirit of the law. You can therefore be expecting some mailings which could resemble junk mail and read like gibberish. Watch for such mailings and be sure not to pitch them; ignoring the fine print could cost you money.

According to the Wall Street Journal, these are some things you should be watching for:

Did your interest rate go up?

Many companies have been raising rates to as high as 29.99%. Do you have to accept that change? No. You have the right to “opt out”, which effectively cancels your card for new purchases while continuing to pay off the balance at the old interest rate.  This could also affect trying to do 0% balance transfers on your cards.

Why are credit card companies raising rates before the changes go into effect? Because, if they notify you before February 22 and you do not opt out, you will be stuck with the higher interest rate for both new and existing balances. After the Credit Card Act goes into effect on February 22, any interest raises affect only new transactions unless you are at least 60 days behind in your payments. Their ploy of raising rates now is to make you pay the higher rates on all existing balances.

You may be asking, “Will opting out hurt my credit score?” Possibly, but what is more important to you: a slight drop in your credit score or paying more money (all interest) to the credit card company? Suppose you owe $5,000 on your card and you are paying $250 a month. The current interest rate is 11.99% and the company informs you that they are raising it to 24.99%. Opting out will keep that interest at 11.99% until the balance is paid off, saving you over $900 in additional interest fees compared to the 24.99% rate. Stated differently, would you pay $900 in order to avoid a slight dip in your credit rating? I hope not.

My thoughts? Don’t worship your credit score or check your credit score too often. It is only a number which allows you to go into debt. If you avoid debt, your credit score has little relevance to your life.  Not sure what your credit score is? You can always get a free FICO credit score.

Has your credit limit been lowered?

Starting in February, the new law will not allow credit card companies to charge fees (commonly up to $39) for exceeding the credit limit unless the borrower “opts in”. If you do not opt in, your card will be rejected when you try to charge a purchase which will put you over the limit. I like this rule: it forces consumers to pay attention to what they charge. But it could create problems if you bust your limit with a hotel stay or while renting a car.

Whether you have opted in or not, you can avoid fees – or rejection – by setting up e-mail and text alerts with your credit card issuer to notify you when your near your limit.

Is the bank changing how it handles overdrafts on your debit card?

New credit card rules that take effect this summer will not allow banks to charge overdraft fees on debit card transactions unless you opt in. These fees, marketed by banks as conveniences, normally cost consumers up to $35 per overdraft. Not opting in would presumably cause any debit card transaction that creates a negative checking account balance to be refused. Again, I like this idea because it forces the customer to be responsible for knowing his checking account balance at all times.

If tracking your checking account is problematic, you should set up email and text alerts to notify you any time your balance drops below a set threshold.   Another idea:   you can link your checking account to your savings account as a backup for mistakes.  Yes, there will be a small fee (maybe $10) involved if this backup is activated, but $10 is better than a $35 overdraft fee.

Concluding thoughts

While the new laws will benefit consumers, now is the time for vigilance. It is your job to know the laws and to keep a wary eye on your credit card correspondence, especially between now and February 22 when many of the rules kick in.

One easy alternative to watching for credit card trickery is to cut up your credit cards. Yes, I really did say that and I challenge you to consider doing so. My wife and I have not owned a credit card in nearly five years and we love the peace in knowing that we no longer do business with slimy companies who have proven themselves to be less than honorable.

With the stroke of a pen on May 22, President Obama authorized major changes to the way American credit card issuers do business. In the President’s view, these are “common-sense reforms designed to protect consumers.” Consumer advocates are rejoicing, but banks are already contending that the reforms might be bad for cardholders in the long term. Here is a rundown of the notable changes within the Credit Card Accountability, Responsibility and Disclosure Act (CARD). Some of these changes will happen in 2010; others will occur within 90 days.

No surprise interest rate increases.

If your credit card company wants to hike interest rates, it will now have to inform you at least 45 days beforehand and tell you why in writing.

New restrictions on retroactive rate increases.

Under the new law, the interest rate on an existing balance cannot increase unless the customer is more than 60 days behind on a payment. Get this, though: even if that happens, the credit card company will have to restore the prior, lower interest rate if you pay the minimum balance on time for the six months that follow.

Statements mailed 21 days in advance.

The new rules say that your monthly bill has to be mailed to you by the credit card company at least 21 days prior to the payment due date.

Pay before 5:00pm EST and you are on time.

That’s right: all credit card payments made before 5:00pm Eastern Standard Time will be considered paid on that day. If your payment due date falls on a holiday, a weekend, or any day on which the credit card issuer is closed for business, your payment cannot be subject to late fees.

You can choose to attack the highest interest rates.

Do you pay different rates for different kinds of credit card transactions? Under the new law, you will be able to apply any payment above the minimum to your highest-rate balance.

More protection for teens and young adults.

The new legislation bars companies from issuing cards to most people under age 21. Those younger than 21 will only be able to use a credit card under one of the following conditions:

• They can prove they have the means to pay the debt (or their parent or guardian promises to pay it off if they default)
• They are emancipated minors
• They are designated secondary cardholders on a parent or legal guardian’s account.

No exploitation of college students.

College-age Americans will still be able to get credit, but within reason. Account limits will be either 20% of their annual income or $500, whichever is greater. So the market for student credit cards will grow less attractive for credit card companies.

An end to universal default.

If you make a late payment to one credit card issuer, other issuers will not be able to hike your rate as a consequence.

Cardholder permission for over-limit fees.

Credit card companies now have to get your OK before they can process a transaction that would put your account over its limit.

Why are credit card companies crying?

Cut out all the nickel-and-diming, and credit card issuers will be left with lower revenues. So where are they going to get the money back? Think reduced rewards for cardholders. Think new and inventive annual fees.

Just because new credit card rules have been implemented doesn’t mean you shouldn’t read the fine print.  With the recent changes, you can bet that credit card companies are already looking for loop holes.  Tread cautiously.  And keep double checking to make sure your best credit cards don’t change the rules on you.

photo credit: Andres Rueda

Also banned: Selling of students’ personal information

I applaud the Illinois lawmakers and Governor Pat Quinn for passing legislation which bans the gimmicky marketing of credit cards to college students. The bill, which won’t take effect until January, could impose fines on colleges and universities if they allow credit card companies to offer free gifts when marketing their products on campuses.

According to State Treasurer Alexi Giannoulias, who lobbied for the new law,

“Too many students have had to learn the hard way that there is nothing free about these gifts.”

Giannoulias noted that college students can run up huge debts that, when unpaid will remain on their credit histories for years after graduation, affecting their abilities to purchase homes or vehicles.

Credit Cards and College Students

I totally agree, adding this statistic: the Jump$tart Coalition for Personal Financial Literacy reported that 19% of all bankruptcies are filed by people under age 25. “How,” I ask myself, “could people this young accumulate this much debt?” Yes, they could have huge student loans, but these can’t be bankrupted, so the logical conclusion is credit card debt. And just when did this credit card debt start? These credit card predators, errr..companies, know full well that the minimum age for owning a credit card is the same age as most incoming college freshmen: 18. They also know that many of these young adults are naive about owning a credit card, so they sink their hooks into them with an innocent give-away (Tee shirt, free pizza, etc.). And, as Mr. Giannoulias points out, “too many students learn the hard way that there is nothing free about these cards”.

The new law, House Bill 2352…

also prohibits schools from selling student’s names and personal information to credit card lenders. Did you get that? If not, read it again and let it soak in. I ask you to consider exactly what your universities have been up to. First, they have been receiving payoffs from the credit card companies to allow them to market their students. Secondly, they have been selling the student’s names and personal information to these credit card lenders. “Why” I wonder, “has this even been an issue? Shouldn’t our colleges and universities be protecting their students from vultures instead of making deals with them?” I would like to think that our colleges have a fiduciary relationship with their students, but this is obviously not the case when the price is right. And doing the right thing only when forced by legislation doesn’t improve their credibility.

The measure, which was approved by large margins in both the House and the Senate, affects both four year colleges and community colleges. Again, I applaud Treasurer Alexi Giannoulias, our Governor and our legislators for getting this one right.

One closing thought:

the bill doesn’t go far enough. How about requiring these centers of higher learning to give full disclosure to incoming students and their parents about any and all agreements they have made with credit card companies? Of course this would be nice if done voluntarily, but based on our colleges’ track records, it is not likely to happen.

Readers:  Do credit card companies market students on campus where you live?  What kinds of free give aways do they use?  Do colleges in your state sell students’ names and personal information to credit card companies?

If you accept this challenge, you will be celebrating a debt free diploma. If you ignore it, you will be starting your career burdened by accumulated debt.

Accept the challenge. It won’t be easy, but you can do it. These tips will help.

photo credit: nsaplayer

1. Decide now to avoid debt.

Once you draw the line in the sand, you will figure out how to do it. Without this commitment, you will drift into debt.

Nineteen percent of bankruptcies in the United States are filed by young people age 24 and under. The culprit? Credit card debt.

2. Don’t go.

I know. This column is about graduating without debt. But what if you just aren’t ready to start right now? You should consider working and saving and learning about life. If you later choose to go to college, you will have more purpose, be more motivated, and have a college nest egg.

3. Say “no” to credit card offers.

Once on campus, you will be enticed with free T-shirt offers and free pizza for filling out a credit card application. Don’t do it, even if you don’t plan to use the card.

Nineteen percent of bankruptcies in the United States are filed by young people age 24 and under . The biggest culprit? Credit card debt. There is a 100% chance that you won’t create credit card debt if you don’t own a credit card and succumb to credit card costs.

4. Work.

Plan on working two jobs every summer and one job during the school year. The sacrifices you make today will not only help you avoid debt during college but will also develop a work ethic essential for life after college.

photo credit: wiccked

5. Choose your college based on your budget.

A prestigious diploma can help you get that first job. Your value to your company, however, is based 100% on your performance, not your pedigree. Don’t choose that dream college if you can’t pay for it. Community colleges and state universities will give you a great and affordable education.

Career coach Dan Miller reports that 80% of college graduates, 10 years after graduation, are not working in the field of their major.

6. Don’t bet the ranch on your chosen profession.

Many students rationalize their student debt by telling themselves that this is “good” debt that will give them a great job.

Career coach Dan Miller reports that 80% of college graduates, 10 years after graduation, are not working in the field of their major. And what if you don’t graduate? You still owe the debt! As a financial counselor, I often work with people who still struggle with their college debt years after college.

7. Apply for scholarships: lots of them.

Dave Ramsey, in his book, “The Total Money Makeover”, tells of a high school student who made it her summer job to apply for Scholarships. She actually applied for 1000 scholarships and got turned down by 970 of them. BUT…the 30 which were accepted were worth $38,000! Not a bad summer job!

Your value to your company is based 100% on your job performance, not your pedigree.

8. Take Advance Placement courses and exams.

Many high schools offer college credits for Advance Placement courses. If you can get the college credit while in high school, you will save on college expenses.

9. Find a work co-op program.

Some companies will pay your tuition if you agree to work while going to college, or alternate work and college. Yes, it takes longer, but you are building that resume and learning about the business world while avoiding college debt.  You can even apply for internships that are paid for.  It might give you a chance to see if you like the career before you commit.

10. Join the Military.

photo credit: Army.mil

Of course this is a huge commitment, but some branches of the military allow you to attend college while still in active service. And once discharged, the GI Bill will basically pay for your education.  Usually, there are extra monetary incentives for military members to attend college.

You have the opportunity to avoid this debt before you get it. Grab that opportunity.