Cash-back credit cards lead to more debt, Fed finds

By Dow Jones Newswires-Wall Street Journal
Posted Dec. 29, 2010 at 5:48 a.m.

Credit cards that give cash back prompt consumers to spend more and accrue more debt, according to researchers at the Federal Reserve Bank of Chicago.

The initiation of a 1 percent cash rewards program yielded, on average, a $25 reward each month — and an increase in spending by $68 a month and in credit-card debt of $115 a month, the economists say in a paper to be presented at the American Economic Association meetings next week.

Credit card companies have long enticed users with an array of rewards programs, from airplane miles to hotel rooms and cash back. In 2005, some six billion reward offers were mailed out by the industry, the Chicago Fed economists say. Even small rewards can prompt people to spend more. In many cases, rewards entice people whose cards were dormant to start spending, the study found.

About 11 percent of those who hadn’t use their credit cards in the previous three months made purchases of at least $50 in the first month of the program.

The three economists looked at 12,000 credit card accounts at a financial institution whose identity they don’t disclose over a two-year period ended June 2002. Some of the customers were offered cash-back rewards; others weren’t.

That debts grew faster than spending among those offered cash rewards likely means people reduced their monthly payments more than they increased spending.

The extra debt could mean two things: People spent more overall or they shifted spending to their cash-back rewards card from some other card in their purse or wallet. Sumit Agarwal, one of the co-authors, says the study found both. That means that, for a lot of people, the benefit of a cash-back reward is negated by increased overall spending and debt.

“The right thing for people to do is to move all of their debt and spending from some other card but we actually see them taking on additional debt,” he said.

Agarwal and his co-authors, Sujit Chakravorti and Anna Lunn, also found that reducing the interest rate on credit-card balances prompts consumers to increase their spending on the card. But the data suggest that “many cardholders transferred balances or spending from other credit cards” — presumably higher-interest-rate cards — “to this one at the beginning of the promotion.”

For banks and other card issuers, small rewards programs work as intended, the researchers conclude. “Our analysis suggests that in an extremely competitive credit-card-issuing market, rewards are another tool, along with lower interest rates, to steal customers from competitors.”

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  1. Anne-Marie Hislop Dec. 29, 2010 at 6:50 a.m.

    A current ad encourages stepped up spending. The implication is that one benefits from spending more because of cash back. The TV ad shows men competing to pay for things like coffee at a Starbucks type place with the winner, who had the card offering cash back, swiping his card to pay for the other’s purchase and looking triumphant about it. It is illogical, but probably works. If one pays $4.50 for a cup of coffee and gets $0.04 cents back, paying an additional $4.50 for a second cup so that he can get another $0.04 back is an increased cost of $4.42 over simply paying $4.50 with no “reward” (what a joke) cash back.

  2. 007 Dec. 29, 2010 at 7:59 a.m.

    You can’t fix stupid…..but I’ll bet the government will surely try.

    THIS and the housing collapse is what happens when you give credit to anyone with a pulse, never mind ability to repay.

  3. Wake Up Dec. 29, 2010 at 8:35 a.m.

    I’ve been arguing this one with friends and family for years. If you have good discipline with money, no problem. If you do not, then you are the target of this ruse. The banker who got me in a virtual Nelson to open one of these cards could not understand my lack of interest in it. I told him, “Anything you’re peddling this aggressively isn’t for my benefit.”

  4. Twomanydogs Dec. 29, 2010 at 8:45 a.m.

    Myopic article. For me – it’s money I already planned to spend anyway, but in the past, would have used check, cash or bank debit card instead. Benefit to using the credit card for the purchase is the 1% rebate & added insurance (for larger purchases). Downside to using the credit card is that it costs retailers $$ – cost of which will eventually be passed on to consumers.

  5. forfarksakes Dec. 29, 2010 at 8:56 a.m.

    Earth shattering revelation indeed! How much time and money did these geniuses waste coming to this conclusion?
    Increased spending is exactly what these offers are designed for.

  6. chitownchase Dec. 29, 2010 at 10:09 a.m.

    I recently received a Chase CC with cash back and the whole shebang. I now use my card for all my purchases to get the cash back rewards, I would have otherwise used my debit card for the purchases anyway. I now use my CC and pay it back right away to avoid interest charges.

    My spending has not increased, just the amount of money I’m getting back.

    This works for some people, hazzardous to most others.

  7. How Enlightening Dec. 29, 2010 at 10:41 a.m.

    What a conspiracy!

    I dunno…I try to pay for everything with a cash back card…it adds up. Of course they dont get interest out of me as I pay in full monthly, but cash back cards are the best thing since sliced bread, automatic 1-3% discount on everything :)

  8. Innocent_III Dec. 29, 2010 at 11:11 a.m.

    This article seems to confuse “using the card” with “increaased debt carried month-to-month on the card.”

    Of course, offering a reward is going to increase card use– why else would it be offered? But, it’s unclear that this tends toward carrying more month-to-month debt.

    On its face, a cash-back credit card offers something positive to the consumer. Then again, if it’s financed out of the merchant’s fee, then I can see merchants being unhappy about it.

    But, the customer? Is there thesis truly that the cardholder would be better off without the reward??

  9. mrbobf Dec. 29, 2010 at 6:20 pm

    I use a “cash-back” card for all purchases and pay off the bill every month. The card company credits my account every couple of months with my reward, usually $50 a pop. I consider it a nice dividend.