Caroling, Candy Canes and ... Credit Card Debt?
Moderation and frugality are two words we don’t typically associate with the holidays. With parties to attend, gifts to buy and cookies to bake, we have the tendency to go a bit overboard this time of year, especially when it comes to our spending.
To understand why the holidays bring out our frivolous side, we sat down with Ali Besharat, assistant professor of marketing and Daniels’ resident expert on holiday shopping and credit card debt, to learn why our spending behavior tends to get a bit out of control this time of year, including how this affects the economy and what we can do to curb credit card debt during the holidays.
Q: Regarding our holiday spending behavior, what are some trends you see this time of year?
A: Planning is universal in consumers’ everyday lives. We plan for events in the short term (i.e., Christmas shopping) or long term (i.e., the expense of a vacation two months away). Most of us could do our holiday shopping earlier but postpone it as we think we will have more time in the future. Not everyone plans equally, and individual differences in planning can affect consumer’s spending habits, including incurring credit card debt. Poor planners perceive that they will have more time available in the future, which impedes their ability to make rational purchase decisions. Additionally, holidays give consumers an excuse to spend. Not setting a budget for holiday shopping can cause overspending and irrational financial decisions. On the retail side, there are more promotions during the holiday season. Retailers offer store credit cards that provide additional savings on top of the existing promotions.
Q: Why do we rack up credit card debt during the holidays? Is it just about keeping up with the Joneses? Or do we feel like the holidays give us an excuse to consume?
A: Consumers rack up credit card debt for many reasons, including the desire to keep up with the Joneses and having the excuse to overconsume. The holiday season elicits positive emotional reactions as we remember our best memories with friends and family. When our decisions are emotionally driven, we may overreact in ways we might regret in the future. With the holiday season also comes the stress of crowds, the scarcity of time and the temptation from sales promotions, which can cause consumers to shop under pressure. This leads to consumers making suboptimal decisions, including falling into the trap of sales promotions, which can cause over-purchasing and buyer’s remorse.
Q: In general, what behaviors lead us to accumulate credit card debt?
A: Credit card issuers divide borrowers into two groups: “convenience users,” who pay the full balance each month, and “revolvers,” who allow their balance to rollover from one billing cycle to the next, paying interest charges month to month. Many consumers who carry a credit card balance may find it impossible to get out of debt, because they are primarily paying for accumulated interest charges rather than the cost of their purchases.
Debt revolvers accumulate debt because they borrow money to buy things they cannot pay back. They tend to use their emotional side of their brain, leading to excessive credit card bills. Emotional decisions are not meant to take into account interest rates and debt payment plans. The immediate gratification from impulsive decisions inhibits their ability to think rationally, and they convince themselves to purchase the merchandise now and deal with the payment later.
Q: Does credit card debt affect the greater economy? If so, in what ways?
A: Credit card debt in the United States has steadily grown over the last 13 years because the cost of living has surpassed income growth. While the median household income has increased by 26 percent since 2003, household expenses have increased at a higher rate (e.g., medical costs grew by 51 percent and food/beverage prices by 37 percent). Credit card debt indicates consumers are purchasing goods and services, which fosters economic growth and creates jobs. The concern arises when this debt is not managed properly as it is one of the most expensive types of debt (i.e., the average APR is 15 percent). Prolonged indebtedness cannot easily be sustained, and it is a symptom of living beyond one’s means.
Q: Are there certain products or services for which consumers seem more willing to go into debt?
A: The nature of a product/service is usually classified as hedonic or utilitarian. Hedonic products are those products purchased for fun, excitement or pleasure. Examples include chocolate, designer sunglasses and movie passes. Utilitarian products, on the other hand, are functional in nature and tend to serve instrumental purposes. Appliances, furniture and cookware fall into this category. The decision to buy utilitarian products, which are practical and functional, is mainly cognitively driven. Conversely, the purchase of a hedonic product represents an affective (emotional) decision. Due to the affective nature of hedonic purchases and the anticipation of enjoyment from hedonic consumption, consumers are more likely build an emotional attachment to hedonic products and go into debt to purchase them.
Q: What do you suggest consumers do to minimize their debt during the holidays?
A: The best way to avoid the debt spiral is to stop borrowing money. Research shows that people spend more when paying with a credit card compared to other forms of payment (e.g., cash, check or debit cards) because the pain of payment, the negative feeling of parting with money, is less salient. Thus, plan to pay in cash, write a check or use a no-fee debit card to make your purchases. This method helps track how much you are spending and how much is left in your bank account. To make sure you’re not living beyond your means, periodically review your income and compare it to your expenses and create budgets for different consumption categories. Further, plan early even though you may think you will have plenty of time later. If you don’t have sufficient time now, the chances that you will have less time in the future are quite high.
Q: For those of us who tend to go overboard during the holidays, what can we do to get our finances back on track after borrowing too much?
A: There are a few strategies consumers can use to manage their credit card debt:
1. The “debt snowball” method, which is paying small balances ahead of larger balances, is only fruitful in scenarios of debt reduction in which interest rates among debt accounts do not vary greatly. When you have a balance on more than one credit card and the interest rates among credit cards vary significantly, always pay back the credit card with the highest interest rate first, irrespective of the size of the balance.
2. Know your credit cards’ limits. Using too much of your credit each month can hurt your scores. This is because credit scores assess how much of your credit line you use each month, known as credit utilization. The less you use, the better it is for your score.
3. If you can, schedule due dates to coincide with a paycheck that doesn’t have to cover other major expenses. Doing so reduces your chances of forgetting a bill and incurring expensive late fees or penalty rates.
4. Never choose to pay the suggested “minimum payment,” unless you have no other choice. Always strive to pay the maximum amount of balance, when possible.
5. Since card interest accrues daily, if you have a big balance on your credit card, try to make multiple monthly payments.