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We know what we owe — except for credit card debt

Daniel Ray

A new study takes a fresh look at one of the key facets of the credit card industry, a facet that is at once a foundational underpinning of a multibillion dollar industry and a gauzy mystery: the fog that comes over consumers when they spend with a credit card.

The new study is titled “Do We Know What We Owe?” and the authors quickly answer their own question: Yes — except for credit card debt.

The researchers looked at the differences between what people said they owed and the hard numbers from lenders showing what they really owed. It was “strikingly similar” for most loans, say the researchers, a quartet of staffers from the New York Federal Reserve Bank. People knew and reported accurately their debts on mortgages, car loans, student loans and home equity loans. The exception: credit card debt. People substantially under-report what they owe on credit cards — by a third to a half, the researchers say.

Yet, they say, if folks really get into debt trouble and have to declare bankruptcy, they snap back to reality and accurately report their situation.

The researchers didn’t pin down a cause — they speculated that it may be financial ignorance or shame — but they said it’s certain that there’s something different about credit cards that makes us not acknowledge our debt, and to spend more with plastic than we would with cash.

That’s what the industry has always counted on, and there’s a long history of research to back it up.

My favorite is a paper from MIT called “Always Leave Home Without It” and it’s a 2000 case study that sought to measure how much people would pay for a pair of Boston Celtics tickets if they had to pay with cash, versus how much they’d pay with a credit card. (A digression: These were primo tickets. They were to a sold-out Boston Garden for the final regular-season game against the Miami Heat, and the Celtics needed to win in order to clinch the division title.)

The answer: Bostonians would pay a lot — and they’d pay a lot more if they used a credit card.

The study also cites earlier research papers showing how people tip more with credit cards, buy more stuff at department stores and tend to underestimate what they spent when asked to recall it. Together, the studies built a case that there was a “credit card premium” that was due to people disassociating the credit card from the actual cost.  In their minds, spending with a credit card didn’t seem to cost the same as cash, so they spent more with credit cards.

Studies showing the existence of that premium became woven into the pitches that Visa and MasterCard make to merchants to get them to accept cards. And once credit cards became established in the U.S. marketplace, the belief in the credit card premium was a big reason that despite their loud griping over interchange fees, you rarely saw a merchant stop accepting credit cards.

But I do wonder if the same results would emerge now. Americans have been hit so hard by debt whiplash that many abandoned their credit cards. The “credit card premium” turned to “credit card toxicity” for many. We hear every day from people who were burned by credit card debt during the recession, and we also hear from those who handled credit cards responsibly and feel put off by how their credit card issuers treated them. I think the number of people who don’t link using credit cards to real money has diminished.

I believe that many of those who are still carrying and using credit cards have wised up and aren’t as likely to be blissfully ignorant or forgetful of their true cost.

The New York Fed researchers say they’ll look at the first post-recession data from consumers when the next triennial Federal Reserve Survey of Consumer Finances comes out in mid-2012. I’ll be interested, too, to see if the cold splash of recession have finally washed away the “credit card premium.”

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  • I think the most amazing stat in the paper is the discrepancy in the aggregate credit card debt totals, as reported by the borrowers and lenders. Americans think they owe $391 billion on credit cards, while the issuers estimate the figure to be $820 billion. Even after allowing for the various adjustments the researchers cite, the figure reported by cardholders only rises to between 52% and 66% of the one reported by issuers.
    It is simply incredible that what Americans think they owe on their credit cards is only half of what the actual total is. Moreover, if Americans can’t figure out or don’t want to know how much they owe on credit cards, how they can know exactly how much they owe in all other debt categories, which is what the NY Fed tells us.

  • I watched a few episodes of a show on hulu a couple years ago about young women who had gotten themselves into bad financial situations. Most of them lived on a combination of credit cards, loans and parental subsidies. The first step was for them to write down what they thought they owed in each category, and then write the total. When the financial guru told them what they actually owed, it was pretty much always substantially more. It was kind of shocking, but also a good warning to keep a close eye on your finances. Maybe you’re doing fine at keeping a mental tally on what you’ve spent, but forget to update your mental tally of the interest, or you forget that your whole payment doesn’t go toward the principal.