This is Your Brain on Credit Cards

According to recent figures from the RBA, Australia has $40 Billion dollar’s worth of credit card debt. The data collected reflects the balances and not the limits. The good news is that we are down from the $52 Billion debt level of 2018. However, you must wonder why we have such a love of credit cards.

MIT Study on Credit Cards Research has shown time and time again that people will spend more with a credit card than they do with cash. In 2021, an MIT study took this further utilizing fMRI technology to look at the brain at the point of purchase. It shows that purchases with a credit card activates reward networks in our brain. The same network which is exploited by addictive drugs such as cocaine and amphetamines. Cash purchases on the other hand do not have the same reaction.

How are we meant to stick to a budget and control our spending when something as simple as a credit card is leveraging neural reward mechanisms to make us spend even more? Even if we are in the 55% of people who clear their balance monthly, we are still spending more than we would if we were able to make the decision without influence.

I pay off my credit card each month!

You might think that having a credit card doesn’t hurt you financially because you pay it off each month. It’s true, that you may not incur interest, and some credit cards don’t have fees. However, even if the above study doesn’t put you off, did you know it also can affect a home loan application?

When you apply for a home loan, your credit card is assessed at the limit and not the balance, even if you pay it off every month. As a general rule, your borrowing power will be reduced 5-6 times your credit card limit. So a credit card of $10,000 will reduce your home loan amount by around $50K. You may not be interested in buying a home, but making changes to your loan, refinancing, and even selling a cross-collateralised property, can trigger the bank to reassess your borrowing power.

There is also the occasional cash advance that can catch people. Sometimes a purchase transaction can actually be processed as a cash advance. This means that you will be paying interest on this particular transaction from day 1 as well as a cash advance fee. In some cases, it will be one or the other rather than both.

Remember, if you do get caught out with interest, it will take 2 cycles to completely clear it off interest charges. This is due to residual interest.

I only use it for reward points:

I have done calculations on many different cards and reward schemes over the years. The amount of money you need to spend is phenomenal! There is a small percentage of people who make it work, however, even they can succumb to being caught by temptation, and circumstances or even not realizing the amount they spend in fees and credit card surcharges. It’s easy to add up all the surcharges, fees and in some cases, if you are not careful, interest however it’s hard to quantify the amount you would have spent if you were not using a credit card incentivized by not only the rewards program, but the chemical reaction in your brain we discussed above.

I only got the credit card to help build my credit rating:

You do not need a credit card to have a good credit score. You would be surprised how much actually feeds into your credit score. Paying your utility bills and phone plan has a great effect on your credit score as well as not having any delinquents or judgments against you. It’s much more important to make sure your bills are paid on time than to worry about a credit facility. People get home loans every day who have never had debt, however a long-standing overdue phone bill, as an example, can be a problem.

Have a think about whether a credit card is right for you, your financial decisions, and your financial future.