High Credit Limits Encourage Consumers To Spend More

The more credulous you are, either because you’re new to the whole line-of-credit experience or because you’re uneducated, the more likely you are to mistake a high line of credit for an indication of your future earnings potential. You can see how this can lead to bad things, as noted by the researchers who studied this unfortunate problem earlier this decade. Luckily, the savvier you get about credit cards, the less influence your credit limit has on you, which is yet another great reason to make financial literacy education mandatory.

“The Effect of Credit on Spending Decisions” [Marketing Science]
(Photo: Photocapy)

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  1. Scott Werner says:

    I think financial literacy education should be provided every year of grammar school. I never once thought that my cc limit influences my decision to buy anything. I use credit cards when I want extra warranties or protection when buying. I don’t understand how people just swipe it without thinking.

    • redlikerubies says:

      @Scott Werner: I know; my parents always wrote it out of their checkbook balance, same as cash, and I learned to do the same. So I know I’ve already “spent” the money by the time the bill comes. Then just pay it off and use the eventual cash back (or airline miles or whatever) for something sweet. I just got $60 in the mail and I have never incurred 1 cent of interest.

    • Outrun1986 says:

      @Scott Werner: I was taught about credit cards in high school, including the very fact that if you carry a balance you will be paying interest on it, but its obvious they are not teaching these things nowadays, or people just say ooo shiny want it now way too much!

  2. Brontide says:

    Credit cards detach the pleasure of buying with the pain of reconciling. Combine with poor budgeting skills and it’s a recipe for disaster.

    I agree that basic financial literacy should be part of “home ec” and not just balancing a checkbook, but appropriate use of credit, budgeting, and long term planning.

    • Eyebrows McGee (now with double the baby!) says:

      @snowmoon: “Credit cards detach the pleasure of buying with the pain of reconciling.”

      I know we have this conversation every time we do “can credit cards be useful?” but I wanna do it again anyway. :D For me, swiping the card is “worse” than paying cash. I keep a mental tally of my credit card spending and my checking account balance, but once cash is in my pocket, since it’s off the ledger, it’s “already spent.” I tend to spend more on stupid stuff with cash than with credit. Knowing that that bill is looming over me at the end of the month makes it a much BIGGER deal to use the credit card than being able to pay cash and have it immediately off my mind.

      But the key there is — you gotta learn how your brain works and psych yourself out. My way of managing money would be a NIGHTMARE for anyone for whom the credit card is imaginary money. (Which is how I feel about the ATM card — that money just keeps coming out of a hole in the wall and it’s all freeeeeeee! Which is a big part of why I don’t have an ATM card.)

      I have a friend who’s very frugal and money-savvy, but for some reason when you hand her a credit card, it’s like all her financial skills turn off. So she and her husband don’t use them anymore. We have basically the same values and goals with money … but either of us would be a CATASTROPHE using the other’s money-management METHOD.

  3. stevejust says:

    Though, to be fair to the “stupid” people out there, the Rick Santelli “losers” who have mortgages they can’t afford — banks changed the lending rules, and common perception hasn’t caught up to the new rules.

    Anyone who’s seen the Movie Maxed Out [[www.maxedoutmovie.com]]
    or read the book Maxed Out knows that banks changed they way they do business in a fundamental way when they stopped concentrating on making money by giving loans to people who could afford them and started extending credit to people who were likely to rack up finance charges and late fees.

    Too many people still believe banks are operating under the old paradigm that dictated that they would only lend you money they determined you could pay back. And a lot of people don’t realize that their credit score isn’t tied to their income, which, frankly, is preposterous.

    • mrgenius says:

      @stevejust: I am not sure what the official Consumerist line on this is, but it seems like on one hand the credit card companies are bad because they cut your credit limit, and on the other, they’re bad because they give too much credit to everyone else.

      I guess I think of the credit lending model like I do buying bonds. If you have poor credit, you SHOULD pay more. That’s the risk premium. Just like if I buy a Ford bond, I would expect to get paid more than if I bought a treasury bond due to the risk of default.

      I guess because no one is forced to use unsecured credit, I don’t feel that badly for those who use it irresponsibly.

      • stevejust says:

        @mrgenius: And my response to you is that because no one is forced to use unsecured credit, I don’t feel that badly for banks who loaned money out and aren’t going to get it back because they loaned it to irresponsible people.

        At the end of the day, the buck stops at the bank (literally). What I feel badly about is the fact that the whole economic system is in the shitter because of what the banks did. The dumbass consumers shouldn’t necessarily share in that blame because banks rewrote the rules and didn’t bother to mention it.

        • mrgenius says:

          @stevejust: I don’t feel badly for the banks either. I guess I was just trying to point out that borrowers with poor credit should be expected to pay higher interest. Lenders who make poor decisions (i.e. Citi, B of A, Morgan, etc) will have their credit ratings go down and will also be forced to pay higher interest on their debt. This is the way it should work, and I don’t feel bad for banks who are unable to manage their risk, any more than I do people who choose to live beyond their means.

          I am not sure what any rule changes by the banks would matter in this respect because a zero balance on a $500 limit 25% interest card is no different than a zero balance on a $15,000 3.25% interest card.

          I also want to make clear I am only talking about the credit card situation here. I think what the banks were doing with the mortgage situation is far different. I feel much more sympathy for those homeowners who were swindled and/or bait and switch with really confusing or misleading mortgage terms.

        • enm4r says:

          @stevejust: I hope you don’t feel badly for the individuals who maxed out cards and jumped into 5/1 ARMs they knew they’d never be able to afford.

          I agree in that I don’t feel bad for the banks (and I work for one.) In no world is it wise to leverage 30+ to 1, let alone when you are leveraging to make risky loans. But I also don’t feel bad for people who can’t do simple math. We can complain about education all we want, and there are some valid points. But what it comes down to is that people entered loan agreements simple “intro payment x length of terms < MSRP.” If you can’t do the simple math, you shouldn’t even have a loan, period.

      • Eyebrows McGee (now with double the baby!) says:

        @mrgenius: I think the official line is that credit cards do things arbitrarily and with no warning, and that’s bad for consumers. :) It’s not necessarily bad for people to have high credit lines, or for people who are risky to pay high rates … but it’s bad when the changes are sneaky, sprung on you, all the terms are unfavorable to the consumer, etc.

        I’d be furious if my CC cut my limit with no warning or explanation. (Frankly it’s kind of annoying when they RAISE it with no warning or explanation.) I mostly don’t mind playing by their rules, but what I *DO* mind is that they never make it clear what the rules ARE, and you get rewarded or punished seemingly at random. It’s hard to be a good and responsible consumer when you don’t know what the “right” behaviors are.

        • enm4r says:

          @Eyebrows McGee (on Twitter: LPetelle): But would you be furious if you the bank came back and said “you are a risky borrower, we are cutting your limit from $5000 to $500.” Because honestly, banks NEED to do that to be responsible. But what happens when they do? Everyone throws a fit because now people can’t buy groceries.

          The fact that we don’t know the rules to the game is a separate issue, and I agree with you on that. But the fact remains that there is still a many many credit lines out there that should be responsibly cut without having to hear about Gloria Alred filing another lawsuit.

          • Eyebrows McGee (now with double the baby!) says:

            @enm4r: “But would you be furious if you the bank came back and said “you are a risky borrower, we are cutting your limit from $5000 to $500.””

            No. If my card said, “We’re lowering your limit to X, and here’s why we’re doing that,” I’m okay with that. I might be a bit put out, but as long as the rules are CLEAR and actions have reasons and explanations, I think that’s fine. (And presumably I could then fix my bad ways to get a better limit, if I wanted to.)

            It’s the randomness and the opacity that I object to as a consumer. I don’t object to them controlling risk, I don’t object to them making a profit. I object to the fact that I, as a consumer, can’t make good decisions because I have NO IDEA what their secret rules are.

        • mrgenius says:

          @Eyebrows McGee (on Twitter: LPetelle): I agree that credit cards do weird shit all the time that’s not good for consumers. I think what I was getting at here is that it’s part of the great circle of credit life that it’s built into the system that there are people who are greater risks than others. Those who pose those greater risks should pay more to access credit (which, in effect, subsidizes and rewards those with good credit).

          In reality, if credit cards cut everyones limits and discouraged irresponsible spending by subprime borrowers, rates for everyone would increase to make ups for the lost revenues. They make MUCH more money on high interest rates and fees than they lose in defaults.

          I wholeheartedly agree that the credit card companies should be compelled to provide clear terms to cardholders. In fact, I think any change they make must include an opt-in or close your account feature. But I don’t think they should be forced to arbitrarily maintain a set interest or credit limits.

  4. Anonymous says:

    I have a radical idea – don’t use credit cards to buy stuff. You’d be surprised how liberating it is to get a bill every month that says “Balance: $0.00″ and “Amount Due: $0.00″.

    • mrgenius says:

      @MeSoHornsby:

      Hear, hear! I can’t figure out for the life of me why people can’t seem to live within their means. I was watching Dateline where they followed a few families through the foreclosure process and it was really so sad. Then you see the little girl playing with her Wii, and the old Gamecube in the background, and the Bose stereo system, and on and on. I still feel bad for their circumstances, and it’s terrible to lose a job. But I have to wonder why people want to buy unnecessary things before they have a safety net in place.

      And before anyone accuses me of class warfare quite yet, I graduated from college with 17k in CC debt and $20k in student loans. My first job paid $30k. I had to live with two others in a one bedroom for almost two years. I paid it all off within four years. You just have to do without sometimes. If you can’t afford to pay in cash, don’t buy it.

      • floraposte says:

        @mrgenius: The thing is, it’s perfectly possible to have credit cards and live within your means. It’s just that there are people who have difficulty putting a psychological limit on their credit spending that’s tighter than the bank’s limit. The rest of us are fine.

        As Eyebrows suggests, you gotta know your own patterns and weaknesses

        • mrgenius says:

          @floraposte: I didn’t mean to insinuate that one can’t live within their means with credit cards. I have three and I use them regularly, though I pay them off monthly.

    • Segador says:

      @MeSoHornsby: Or even, to not get a bill at all. Zero credit cards FTW.

  5. pecan 3.14159265 says:

    I see a high line of credit as something akin to trust. Trust is something that can be misused, misguided, and mishandled. There is nothing inherently wrong about trusting a consumer with a high line of credit – but once that person proves to be abusive, companies have a responsibility to look at the bigger picture, which is that lots of people in debt is worse for them in the long run, even if they’re making a lot of money in debt and fees right now.

    People who are allowed to spend $10,000 without a thought as to how they will pay it back do not deserve more than they can handle. I agree with everyone who says that basic economics and credit courses should be included in education. I would also say that it should be required in middle school, junior high and high school, not only to keep up with the trends and developments in markets and in credit, but also to educate consumers as they grow up. Things you learn in middle school certainly aren’t going to be as applicable when you’re 18 because the way things are done is always changing.

  6. corinthos says:

    I called to cancel my chase cards yesterday and they kept trying to get me to transfer the balance instead and up my limit. Funny that I never even use half of my previous limit anyways so why would I care to have more. Guess they wanted me to buy some really expensive stuff.

  7. Terraxsu says:

    I know he’s no expert himself, but Robert Kiyosaki (author of “Rich Dad, Poor Dad”) has been a proponent of integrating financial education into our school system for years now. I’ve somehow learned to live within my means, save for the future, and understand how personal finances work without living the destitute lifestyle those individuals in question seem to feel it takes to do so. To be fair though, I did grow up to get an MBA and work as a financial analyst for a bank so I’m obviously not representative of the norm. I think teaching kids in elementary, middle, and high school the basics of the financial system and how it pertains to them as well as ‘the value of the dollar’ (ie the work it takes to earn one) would go a long way.

    On a personal note, it might cure all of those children from growing up with an entitlement mentality that makes them virtually un-dateable. lol I’ve met way too many young ladies whose parents gave them everything without having them learn the responsibility that accompanies earning it. It makes it harder for them to reconcile why we couldn’t afford to always go out to here or there all willy-nilly.

    • mrgenius says:

      @Terraxsu: You think getting sex-ed in the schools is hard, I bet this would be harder! The credit card lobby would rapidly attempt to quash ANY discussion of financial responsibility among schoolchildren. And of course, it would be framed on Drudge as Obama trying to get into our schools to indoctrinate our kids in Marxism :)

  8. AnonymousFinger says:

    I rarely use my BoA Visa (credit), but every time I do, I pay off the balance usually within a month, sometimes a little longer. Every time I did, they raised my credit limit. It’s now at 14.5k. Why the heck am I going to ever need 14.5k worth of credit @ 14.99% APR? My Credit union just lowered my CU Visa to 9.99% APR. Pays to have good credit with a ZERO balance i guess.

  9. MarkMadsen'sDanceInstructor says:

    Well, credit card companies tend to give high credit limits to the people that are least likely to use them. For example, I have a $20k limit on my BoA card, but I doubt I’ve ever used more than $100 of the limit, and I’ve never paid a single cent in terest.

  10. albear says:

    I have a 25K limit credit card but have never gone even remotely to that. The most was like 2K in a month (but paid it off)

    Since using credit cards since 1990 I have never paid a cent in interest to credit card companies. (I bet they hate me) And my fico credit score is a nice 808 (the last time I checked)

  11. ARP says:

    There is a huge emotional component to money that most people ignore.

    Maybe they were just spoiled brats and got everything they wanted growing up. When they went out on their own, they didn’t have an an emotional understanding (I think most have the intellectual understanding) of what happens. They assumed at $75k job would land in their laps and they’d pay it all off. Of course, then the real world entered and now they’re over their heads.

    There were those who have been poor their entire life and now they have the chance to buy something nice, even if they can’t really afford it.

    There is the powerful dispair of realizing you have $30k in credit card debt and won’t pay it off anytime soon. Sometimes it feels so overwhelming that some choose to ignore it.

    Add to that all the media focus on material things and there are powerful emotional forces at work.

    I’m not trying to excuse any behavior or say they should not pay back the money, but I think the simplistic answers of “just don’t spend more than you have,” or “just pay it all off right away” ignores a lot of the issues and assumes they don’t get that. They get it, but there are emotional complications at work. It’s like telling someone, “just be nicer,” “just loose weight,” “just don’t feel that way.” These people need to manage your money in a way that matches their personality (e.g. locking their credit card in a safety deposit box, lowering their limit, etc) and then do some self-reflection on why they think they need that thing. Yes, its touchy-feely but I don’t think the, “just don’t do that” always works.

    • floraposte says:

      @ARP: I totally agree with this. (And that’s why I find behavioral economics so interesting.) You really have to find the way that works for your own money habits. I just disagree when people don’t grasp that that works both ways–that a way of doing something isn’t inherently bad just because they have problems with it.

      • johnva says:

        @ARP: We also need to recognize that not everyone has the SAME emotional responses to money issues. Some people feel one way about it, while others feel another way, and that influences their behavior. There is no one-size-fits-all approach, which is something that a lot of people miss.

        Some people like the security of paying down their mortgage in 10 years because it makes them feel positively. Others would not do it that way because they don’t have the same sort of emotional need for security and want to invest their money elsewhere. Same with credit cards: some people see them as “fake money” and can’t control their spending when they use them, maybe because their emotional connection to their money is actually based on the literal pieces of cash. Other people, like me, don’t have that same response to credit cards, maybe because I’ve never been a big user of cash in my life and thus never learned that sort of attachment to cash.

  12. Eyebrows McGee (now with double the baby!) says:

    We have mandatory financial/consumer education in Illinois that you must pass to graduate from high school. Been around 20+ years. Illinoisians are not notably savvier with money than our uneducated neighbors.

    What would it take to make these programs EFFECTIVE?

    • enm4r says:

      @Eyebrows McGee (on Twitter: LPetelle): I’d say the same thing about PE. Mandatory in Illinois, yet when I moved here there was no noticable drop in waist size. :)

      To make it effective you have to make high schoolers care, and they won’t because primarily, their parents do not. This type of education is only effective in school when the exposure starts at home.

  13. opsomath says:

    I’m sorry, but there is a massive non sequitur between the conclusions of the article and requiring “mandatory financial literacy education” – and I don’t feel that the Consumerist is doing us any favors by advocating it so strongly. I have run up against a mandatory education area twice in the past, oh, decade; mandatory health classes as a freshman in college, and mandatory driver’s education classes. Both of them were a fantastic waste of time.

    You can argue that that is because I had a good grounding in both of those areas going in, and that the purpose of the initiative would be to help people who did not; however, I remember the bored expressions of my classmates and doubt intensely that the classes managed to influence anyone in a few short weeks.

    Any financial ed program that schools or states implement needs to have proven effectiveness before it’s even considered. Otherwise, it’s like buying extended warranty coverage; it sounds good in principle, but when you look at the results it provides, you get very little real protection. And the Consumerist taught me not to buy those.

  14. Chris Walters says:

    Re. what to teach -

    I don’t know what current financial ed curricula are like, but if they focus solely on things like “how interest works” and “setting a budget” then I think they’re too narrow. Consumers need to be taught about the emotional component (as ARP describes it above) as well as the business side of the finance industry, including advertising and marketing tricks. That’s not the same as demonizing the financial industry, just to be clear.

    Maybe school age is too young to teach about the life-cycle hypothesis or “temporal optimization” (I’d never heard those terms until today), but you don’t need to know the underlying research to teach the result, which in this study is: there’s a natural tendency for a person to misread a credit limit as a predictor of future income, which leads him to borrow against hypothetical future earnings for present purchases. The more he knows about how the credit card industry works, the less likely he is to make that mistake.

    And as far as the life-cycle hypothesis goes, it reminded me of something I’ve been thinking about re. teaching financial literacy: that it makes more sense to view financial health as a single concept that extends across a person’s entire lifespan, as opposed to static snapshots of the present day financial situation. If you could get kids to understand that no matter where they are in their lives, their financial situation is a culmination of everything before that point and will extend far beyond the present, it might help to give them the perspective to make more rational choices about personal finances, especially considering the life-myopia of youth. IOW, *you* live in the here and now, but your finances never do, and you’re always simply borrowing from the past or the future when you spend money.

    • Eyebrows McGee (now with double the baby!) says:

      @Chris Walters: From the brochure about the Illinois test (you have to not just take the class but pass a standardized state test), topics covered include:

      THE CONSUMER IN THE MARKETPLACE
      THE CONSUMER IN OUR ECONOMY
      BUDGETING
      SAVING, INVESTING, AND FINANCIAL SERVICES
      CONSUMER CREDIT
      TAXES
      INSURANCE
      CONSUMER SERVICES
      HOUSING
      FOOD
      TRANSPORTATION
      CLOTHING
      HEALTH CARE
      RECREATION
      HOME FURNISHING AND EQUIPMENT

      [www.isbe.state.il.us] has information, including a link to sample test items, which you can view in PDF here: [www.isbe.state.il.us]

  15. Anonymous says:

    Just as I got done reading about how credit card companies are cutting consumer’s lines of credit and even paying some of them to stop using their card, I open my mail today and see that Citibank has raised my limit another $5,000. I don’t know what to make of this. Does this mean I’m a good consumer or a bad consumer? Should I keep the limit or ask them to lower it?

  16. Outrun1986 says:

    I think the reason business classes in high school do not teach marketing trick is because if the students know the tricks then they can’t be marketed to! I think there is a push to keep this stuff out of the schools now because the marketers need to get to the kids more than ever. If we tell kids about credit cards, and you know, stuff they need to know for life, then corporations won’t be able to take advantage of them for the corporations profit in the future!

    I keep saying it, in my high school I was taught everything, how to balance a checkbook, all about credit cards (I certainly didn’t like the idea of paying interest when I first heard about it!), the stock market and even to buy store brands over brand names because they cost less!

    Either that or I just had a really good business class teacher…

  17. Bobby Smith says:

    I just got a letter in the mail today from 1st Financial Bank USA telling me that they are raising my limit from 5,000 to 11,000. I only have a 300 dollar balance on that card, and the reason for the balance is that they do not charge interest as long as you keep your balance below 500 dollars.

  18. Chris Walters says:

    @Eyebrows McGee: Thanks for those links. Wow, looking at that quiz, the content is really all over the map–there are basic life skills and rudimentary skills (filling out a deposit slip, reading a chart) taking up space. I guess I’ve always imagined “financial literacy” to focus solely on personal finance decisions, not things like nutrition or how economic policy works. Those are important, obviously, just could hopefully be better covered elsewhere.

    You realize I’m just making up opinions on the spot. I have no idea about the history or current state of financial education at the public school level.

    Hmm, maybe Consumerist should put together a seminar and go around to public schools yelling at kids. $$$!!!

    • Eyebrows McGee (now with double the baby!) says:

      @Chris Walters: Well, it’s a semester-long class, so they have 16 weeks of content. It tends to focus heavily on what we think of as more traditional “consumer/finance” issues but it does hit on some “home ec” type things (which, of course, are also consumer decisions) and the things like economic policy and marketing strategies and so forth are important to know about to be a more savvy money manager.

      It is called “consumer ed” in Illinois usually, not “financial ed” specifically, so there is some focus on the kinds of places you’ll SPEND your money — housing, food, transit — as well as on how to manage money.

  19. TEW says:

    The thing that had the most impact on me was the power of compounding interests. I am the kind of person that will vote to allow payday loans in a minute but I also want the schools to teach financial literacy. The informed citizen is the cornerstone of a great society.

    I had 12 grand in a capital one bank account and applied for a student credit card and was denied for lack of credit. You might claim that I was spoiled for losing it with a CSR but they did not want my business. I withdrew most of my money the next week.

  20. u1itn0w2day says:

    Credit cards and credit lines will never be seriously regulated for any length time if for no other reason credit is being used to counter overpricing let alone over spending .

    If credit is cut too much too many companies would loose out because now they would have to price more competively and carry less choice which would also affect their business .

    The availability and use of credit runs this economy .

  21. Luke Wilson says:

    Even worse, at the end of the month, you have a list of all your transactions staring you in the face. When I spend cash, it’s out of sight, out of mind. But the credit and debit cards don’t let you forget where all your money went.