Rewards Credit Cards Lead to More Spending and Debt

Credit Cardsphoto © 2008 Andres Rueda | more info (via: Wylio)
I think not. At least not for those of us who are credit card deadbeats.

The last time a Federal Reserve Bank output some research about credit cards, the study left a lot to be desired after one gave it a thorough read. It was a classist piece that basically suggested that the poor, by virtue of paying by cash, were actually subsidizing the purchases of the rich who do use credit cards. There were quite a few unaccounted for variables in their research though, and the research was skewered those savvy in personal finance. One would think that this result would be fresh on their minds before presenting new research likely to draw more attention from the same group of skeptics. However, this apparently is not the case.

In today’s Wall St. Journal, there’s an article on a new study by the Federal Reserve Bank of Chicago called “Why Do Banks Reward their Customers to Use their Credit Cards?” In the article, the authors, Sumit Agarwal, Sujit Chakravorti, and Anna Lunnα, state that in the first quarter after receiving a 1% cashback rewards card, the the rewards-earning cohort they tracked racked up $25 in rewards, spent $68 more, and increased their debt by $115 compared to a control group. This of course is why a bank offers credit card rewards in the first place. The rewards are more than offset by the increase in transactions, level of spending, and revolving balance. Most people are not credit card deadbeats like me who never carry a balance.

Interestingly, the authors state,

“Segmenting the data by different types of cardholders, we find that cardholders who do not use their card prior to the cash-back program increase their spending and debt more than cardholders with debt prior to the cash-back program.”

What this means is that for those consumers who weren’t using their credit card before the rewards program, the program served as an even stronger stimulus to their spending and card usage. That’s great for the credit card companies.

OK, that’s interesting, but what about the guys like us, the deadbeats. Well 29.28% of the sample were deadbeats, according to the authors. That is, they were not identified as “revolvers” (those carrying debt prior to the program introduction). That means that the deadbeats include people with credit cards that were simply not using them as well. Although they mention these two deadbeat sub-groups, they never break them out in terms of size. They go on to say that many of these non-revolvers become revolvers in subsequent months which suggests to me that a sizable portion of the deadbeat population was simply an inactive user population.

The takeaways for me from this read is that we, the proud deadbeats, are a very small portion of the credit card using public, and that in spite of recent regulatory changes regarding merchant and transaction fee limits, rewards cards are here to stay because they are WAY too profitable to walk away from for the credit card companies.

There are some key caveats to this research I should note:

1) It’s old data. June 2000 – June 2002. This is not a big issue, but the times have changed.
2) They only have credit card data, not personal spending data. That means they can see that one shifts (substitutes) spending from one credit card to the rewards credit card which makes sense, but they have no idea what your overall level of spending is. This is a bigger issue.
3) Limited demographic data prevents matching respondents from the rewards program compared to the non-rewards program.

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  • Jan

    If there is one thing I gathered early on when these rewards for using a credit card first originated was that it had the potential to increase the cards usage in order to gain points towards travel or whatever was the flavor of the month.

    Then when Anset Airlines collapsed and everyone who had points racked up on their CC to gain a free seat, lost out big time, I was really glad to have decided not to take part in the chase for a place.

    • Jan,

      I certainly agree that there is potential to increase card usage as a result of CC rewards. The key is to be disciplined. You just buy the merchandise you always buy.

      You make a great point about airline miles. This is one of the reasons I have no miles cards. The other reason is that airlines frequently devalue your points by increasing the number you need to get a free ticket, in addition to issues around blackout dates. It’s too much hassle for me. I prefer cashback.

  • Steve

    After making mistakes in my early to mid 20s with credit cards (and paying for those mistakes for many years), thankfully I’ve reached the point in my 40s where I pay off my cash reward card each and every month. I use it for everything possible– groceries, gas, Rx, etc.– and (knock on wood) am happy that I’m getting from 1% up to 5% back as cash to apply straight to my statement. Pretty sweet deal for me (as long as I never, ever pay 1 cent of interest to the da*n bank).

  • Steve

    …but to the point of the post: no, I honestly don’t believe that it increases my overall spending. When I go to the supermarket, I have a list and stick to it. Knowing that I’m going to pay with my rewards credit card doesn’t make me spend more than had I paid cash.

    • Steve, I full agree. Great work on maximizing your credit card cash rewards! At least some of us are benefiting from credit card company policies. The few, the proud, the credit card deadbeats!