Understanding the Psychology Behind Cash and Credit

Understanding the Psychology Behind Cash and Credit

When it comes to making a purchase, does the method of payment really impact how much you’re willing to spend? It might sound far-fetched at first, but studies show a strong correlation between how you pay and the total amount you’re willing to shell out.

According to a 2000 study titled, “Always Leave Home Without It: A Further Investigation of the Credit-Card Effect on Willingness to Pay,” the number of cases in which credit cards appear to have some impact spending habits are many.

“…it is known that people who own more credit cards make larger purchases per department store visit (Hirschman 1979), and that restaurant tips are larger when payment is by card (Feinberg 1986). There is also evidence that credit card users are more likely to underestimate or forget the amount spent on recent purchases (Soman 1999).”

The study’s authors go on to explain an even more troubling trend – people report being willing to spend 50-200% more on a purchase made with credit vs. with cash.

Whether you are aware of a shift in spending habits based on your payment method, or you’ve never noticed the correlation before, understanding the psychology behind this phenomenon might just help your wallet in a relatively painless way.

Here are a few things to be aware of:

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Credit cards give you the option of making impulse purchases.

If you enter a store with, say, $100 cash and the intention of sticking below that self-imposed spending cap, you have very little wiggle room. Yes, you could leave to find an ATM, but the effort required to do so would probably be a deterrent.

Say instead you enter the same store with the same spending cap but with a credit card in hand instead of cash. Suddenly it becomes easy to justify scooting that cap a little higher. It’s only an extra $10…or $20. If the money is so easy to access, you’re forced to rely soley (typo: should be solely) on your willpower to stick to the original plan.

When money is at your fingertips, impulse purchases can quickly become an everyday struggle.

Credit cards shift the focus away from cost.

A 2011 study published in the Journal of Consumer Research found that consumers tended to focus on a laundry list of other things aside from cost when confronted with the option to buy an expensive item with credit.

“When (consumers are) exposed to new products and thinking about paying with credit, they tend to focus on the good things about the product – the aesthetics of it, the features that are better than other products they’re considering, the sexiness and luxury of it….That’s as opposed to details related to cost, like the price, shipping cost, installation cost and effort.”

Credit cards offer immediate satisfaction without immediate consequences.

An empty wallet is the immediate consequence when you purchase something with cash. The consequence for purchasing with credit, however, isn’t felt for awhile after the fact. So long sometimes that the pain of the original purchase is almost non-existent.

Take this example discussed by NerdWallet:

“Amy Finkelstein’s EX Tax: Tax Salience and Tax Rates found that states with highway tolls would raise the cost of the toll rate when the debit occurred using electronic toll collection versus cash payments. These states realize that they can get away with charging more because an electronic debit isn’t seen as “real money” until the statement arrives.”

Get smart in the credit vs. cash game

 Not everyone’s spending habits are impacted by the same external factors. However, if switching payment methods would help you cut your spending without noticing much of a difference, wouldn’t it be worth it?

Switch to all-cash spending for a week, two weeks, or, if you’re up for it, a month. Compare this to your credit card spending. If you notice a difference, you might have just given yourself an unexpected cushion in your budget – and isn’t that a great way to start the New Year?

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  • Sanjay Prasad

    Nice article.