Dubai: According to several new surveys, consumers around the world are more likely to overspend this year due to pent-up demand and pandemic-driven inflation.
Spending is simply spending more money than you can afford. This is a common problem when easy credit is available.
While Dh30 overspending isn’t a big deal if it only happens once in a while, it can certainly be part of a pattern – a predictable pattern of overspending with credit that can happen to the best of you. we.
Indeed, consumers tend to pay more when they use credit cards rather than cash for their purchases.
Credit card debt reaches unexpected levels
Globally, several statistics show that people on average had a balance on more than 50% of all active credit card accounts in the last quarter of 2021.
Credit card debt grew until the financial collapse of 2008, when balances soared from around $1 trillion (3.67 trillion dirhams) at the end of 2008 to nearly $800 billion (2.9 trillion dirhams) at the start of 2013.
Then, when the pandemic took hold in 2020, credit card debt plunged again, from $1 trillion (Dh3.67 trillion) at the end of 2019 to around $800 billion (Dh2.9 trillion). of Dh) in early 2021.
But at the end of 2021, there was an unprecedented spike, which brought credit debt back to pre-pandemic levels. These are levels that experts say are worrying, given that people tend to spend more this year.
Behavioral economists and psychologists have identified two specific reasons why this payment quirk affects us all.
1. Cash payment associates the pain of payment with purchase
When cash payment associates the pain of payment with purchase, psychologists describe this effect as coupling. Coupling describes how closely an experience of consuming something is related to the experience of paying for it.
When you pay cash for something, your experience of the product is intimately tied to how it feels to pay. For example, if you paid cash to enjoy a night out with a friend, the act of enjoying your night and the act of paying for it would be directly coupled. The pain of paying is felt at about the same time as the pleasure of leaving.
But if you instead pay for your evening with a credit card, the payment is cancelled. You take the pain of paying for the act of enjoying your evening enough that they don’t feel closely associated at all. In other words, you decouple pain from pleasure. This allows you to focus on your enjoyment at the expense of your bottom line.
2. Tendency to focus on the benefits of items purchased on credit, not the costs
An important effect of decoupling payment for an item from the pleasure of buying it is that consumers tend to overvalue the benefits of their purchase.
According to a global retail study, consumers using credit cards pay more attention to the benefits of the product they buy, ignoring the costs. Because the pain of buying the product has been decoupled from its benefits, consumers are more likely to weigh those benefits without considering price.
For example, suppose you have 50 Dh in cash to spend on a meal at a gourmet restaurant. Although the idea sounds great, you don’t want to be short when the restaurant bill comes. So you order from the economy side of the menu and end up with a safe, cheap dish.
If, on the other hand, your plan is to pay for dinner on credit, you have much less reason to worry about the cost of the meal. And that means you’re less likely to think about how much it’ll set you back.
In other words, a restaurant bill coming in for double what you planned to spend can be skipped if you can pay it easily with credit. Refocusing on an item’s costs — or even its cost-benefit analysis — can be very difficult to do when you’ve already decided to pay for something on credit.
How to fight against the effect of credit on your brain?
These psychological quirks are why so many personal finance gurus recommend that you only spend cash on purchases. Paying cash will always keep in mind the pain of paying immediately – and keep you from thinking only of the benefits without considering the costs.
But not everyone is able or willing to switch to a cash-only lifestyle. For regular credit card users, it might be possible to link the pain of payment to the pleasure of shopping by noting the cost of any particular purchase.
This can be particularly useful if the record is a running tally of your credit card charges for the month, which means you constantly force yourself to see what your full credit card payment will be at the end of the month. month. Writing down the cost of each transaction might help you keep the price in mind even if you won’t “pay” until your statement comes to the end of the month.
However, this can be difficult to put into practice. It would take diligence to carry your monthly statement with you. Force yourself to add to the tally every time you pay with plastic. Overall, if you want to force yourself to pay attention to costs and feel the pain of payment, it’s much easier to just carry cash.
This is where it can be beneficial to set aside some “play money” in your budget. Take a few dirhams from each salary and set it aside for times like these. You’ll feel good about your purchase whether you make it with cash or a credit card, but you’ll feel even better if you don’t have to spend the next two years trying to pay it off with 20% interest.
How can I be careful while juggling multiple credit cards?
Generally speaking, the more credit cards you have, the easier it is to overspend. Multiple credit cards increase the amount of credit you have and give you more spending options.
Multiple credit cards also mean you have to manage your balances across all credit cards and be more careful about keeping your combined balances within your personal spending limit.
Monitor your credit card balance, not just your available credit, to make sure you don’t go over your chosen spending limit based on what you can afford. You can ask your credit card issuer to lower your credit limit if it helps you control your credit card spending.
Key points to remember
With credit cards, there’s a lag between making purchases and paying for them, so you hardly realize you’re spending money. You don’t feel the pain of buying like you would if you were using cash, which is one of the reasons people tend to overspend with credit cards.
This trend was demonstrated in a 2001 study from the Massachusetts Institute of Technology (MIT). The study found that participants were willing to pay more for a purchase when using credit cards rather than cash.
Avoid thinking of your credit card as free money, remember that you will have to pay back everything you buy. Hold yourself accountable for what you spend with your credit card, as if you were actually using cash.
If you’ve managed your credit well and have a good income, your credit card issuer will reward you with a higher credit limit. You don’t have to use all of your available credit just because it’s there. Although more available credit increases your purchasing power, having a large credit limit is not the same as having a lot of money in the bank.
Using too much of your available credit can negatively affect your credit score, especially as your balance approaches your credit limit. Ideally, your balance should not exceed 30% of your credit limit.
Since paying off your balance in full is the best way to avoid getting into too much debt, let your current balance influence how much you spend. Set your own personal credit card spending limit based on your income and other expenses, not just your credit limit.