Consumer credit allows people to purchase goods and services instantly and reimburse expenses from time to time. It provides consumers with flexibility in spending and, in some cases, perks and rewards. However, consumer credit can also tempt some people to spend beyond their means.
Pro: Financial flexibility
The only biggest advantage of consumer credit is the financial flexibility it allows. In the days before widespread access to credit cards and other consumer loan options, people often had to save for years to make big purchases.
If your car breaks down or you need a new refrigerator, it can hinder your ability to make a living. Credit allows consumers to allocate key expenses for a monthly or annual period so that they do not have to choose between buying a new transmitter and putting food on the table.
The flexibility offered by credit also allows consumers to make more timely investments. For example, if your house needs some roof repairs, access to credit allows you to pay immediately. If you don’t have credit, you may have to put money aside for months to complete the repairs. Meanwhile, leaks can cause more damage to your home.
Con: Temptation to overspend
Access to credit makes it easy to pay for basic needs and cover urgent expenses, but it also simplifies the purchase of expensive products that you may want but don’t need. Psychologists have found that people often use credit recklessly due to natural human impulses.
Manoj Thomas of Cornell University, for example, studied the grocery shopping habits of 1,000 households over six months. He found that consumers who pay with credit cards are often more impulsive in shopping, loading up their cards when buying junk food and spending more profligately. Thomas and his colleagues argue this is because credit card shoppers feel less “pain at checkout” than those who pay with cash. Cash shoppers understand that they are spending money on a more tangible level and feel that they have moderated their spending.
In another study, researchers at the University of Hong Kong and the University of Colorado found that credit cards with high limits change people’s frame of reference for assessing costs. The researchers suggest that consumers with high lines of credit tend to imagine their lifetime income will be very high, so they spend more comfortably.
People with lower or no credit lines estimate their lifetime income will be lower, so they tend to spend less. A $10 meal at a restaurant may seem expensive compared to the $20 in your wallet but is cheap compared to a credit card with a $5,000 limit.
The problem with overspending is that it leaves consumers drowning in high-interest debt and can cost them a lot in the long run.
Professional: Perks and Rewards
Consumers can earn significant benefits using credit if they use it wisely. Many department stores and car dealerships offer their customers favorable financing options, including late payments and low interest rates. Credit cards typically reward cardholders with cashback offers, frequent flyer miles, and reward points.
For consumers who resist the temptation to overspend and pay off their credit accounts every month, these perks and rewards will become free money. For example, a credit card that earns frequent flyer miles can help you buy a vacation for free. But if you are late in credit card payments, you will have to pay much higher interest than the reward deserves.
If you are disciplined about monthly credit card repayments, you may be wise to choose a credit card with a higher interest rate if it offers better rewards.
Children: Pay interest and penalties
Consumer credit rates are often staggeringly high and can force consumers to pay back many times their original value when they make a purchase. The average annual interest rate on a credit card in the United States reached 21% in 2014 — 5 times higher than the typical rate of a 30-year mortgage, which hovers around 4%. A $1,000 credit card purchase paid off in three years with a 21% interest rate ultimately costs nearly $1,400.
Many credit cards offer low referral rates and skyrocket after a few months or a year.