Credit Cards: Transactional Convenience or Debt‐Trap?

• Author: Stephen Brown,Yulia Veld‐Merkoulova,Chris Veld
• DOI: http://doi.org/10.1111/irfi.12228
• Published date: 01 June 2020
• Date: 01 June 2020

Credit Cards: Transactional

Convenience or Debt-Trap?*

STEPHEN BROWN

†,‡

,CHRIS VELD

‡

AND YULIA VELD-MERKOULOVA

‡

†

David S. Loeb Professor of Finance, Stern School of Business, New York University,

New York, NY and

‡

Department of Banking and Finance, Monash University, Caulfield East, Victoria,

Australia

ABSTRACT

We survey individuals on their credit card usage. Contrary to popular press,

most credit card holders use credit cards in a responsible manner. They tend

to use credit cards for transaction convenience and pay little interest. Only a

minor subset of people uses credit cards to access expensive credit, with only

7% of credit card holders in our sample never paying the balance in full.

Credit card debt is more common among older, less financially literate, and

less trusting respondents. Even individuals with credit card debt are well

aware about its costs and are likely to make informed financial choices.

JEL Codes: D14; D91; G11

Accepted: 20 July 2018

Household debt remains one of the most under-researched areas in finance.

However, the economic significance of household debt is very high. For exam-

ple, in the US, in the fourth quarter of 2016, the ratio of household debt to the

gross domestic product was 80.1%.

1

At the same time, 42.4% of households in

the euro area of the European Union was indebted with a median outstanding

amount of debt (conditional on holding debt) of €28,200.

2

Zinman (2015)

* We thank Anup Basu, Mark Doolan, Pascalis Raimondos, Ayesha Scott, Daniel Smith, Arthur van

Soest, participants at the Q-Group meeting in Melbourne (March 2017), and seminar participants at

the Erasmus University Rotterdam, Deakin University, Queensland University of Technology, and

University of Glasgow for their helpful comments and Marije Oudejans for her help with the panel

data. Special thanks go to an anonymous reviewer, and Xiaoyun Yu (the Editor) for their useful

insights. The authors acknowledge financial support from the Monash Business School and La

Chaire Dauphine ENSEA Groupama “Les particuliers face au risque”of the Fondation du Risque and

L’Agence Nationale de la Recherche in the context of the project ANR Risk.

1 Source: Federal Reserve Bank of St. Louis, https://fred.stlouisfed.org/series/HDTGPDUSQ163N,

retrieved on November 27, 2017.

2 Source: Household Finance and Consumption Network survey of the European Central Bank.

Second wave, December 2016. See: https://www.ecb.europa.eu/pub/pdf/scpsps/ecbsp18.en.

pdf, retrieved on November 27, 2017.

© 2018 International Review of Finance Ltd. 2018

International Review of Finance, 20:2, 2020: pp. 295–322

DOI: 10.1111/irfi.12228

argues that research on household debt has lagged both research on the asset

side of the household balance sheet and research on corporate debt.

Among household debt, credit card debt is often cited as a major source of

financial problems, with multiple government and nonprofit services trying to

educate presumably ignorant consumers about the hazards of such debt. For

example, many publications and websites give advice on how to handle debt.

This advice usually comes down to limiting credit card debt. The website Bank-

rate lists “10 bad money habits that lead to debt disaster.”They write, “If you

have to reach for plastic to make it through the month, that’s a huge red flag.”

3

Despite the large number of articles in the (financial) press arguing that per-

sonal debt levels, particularly credit card debt levels, are unsustainable, there is

relatively little research on exactly how individuals and households use credit

cards. In this paper, we study debt-related decisions at the individual level.

While households carry large amounts of debt, previous studies argue that indi-

viduals do not rationally handle debt (e.g., Ausubel 1991). Cargill and Wendel

(1996) document that credit card holders do not search for low credit card

interest rates because they expect to use the cards only for transaction conve-

nience rather than as a source of credit. However, some credit card holders do

carry positive balances and therefore pay credit card interest. By not shopping

for low interest rates, they act irrationally. Another example of unexplained

borrowers’behavior is the so-called credit card debt puzzle, where holders of

high-interest credit card debt often also have money available in bank accounts,

which pay very little interest (Gross and Souleles 2002; Telyukova 2013).

We employ a well-established survey panel representative of the population

of the Netherlands to study determinants of credit card use. We find that, con-

trary to the financial press and previous studies, which view credit cards primar-

ily as an expensive and irrational form of debt, credit card use is largely well-

informed and restrained. Many credit card users emphasize their value as a

method of payment. They value, for example, the convenience of a credit card

to make payments both domestically and abroad. These credit card holders act

responsibly and, most of the time, avoid paying interest charges altogether.

More than 80% of our sample always pays off the balance, either automatically

(36% of our sample) or otherwise (46%). Only a small part of credit card users

use their credit cards to access expensive credit and only 7% of our sample

always carries a full balance. Even this small group of credit card debt holders

may well be acting rationally if the marginal utility of the increase in their cur-

rent consumption due to credit card debt outweighs the marginal costs of

this debt.

For the subsample of credit card debt holders, our results complement the

studies of Tan et al. (2011), Telyukova (2013), and Kuchler (2016), which focus

on individuals with credit card balances. We find that, even in this subsample,

most of the time, households are aware of their credit card debt and its costs.

3 See http://www.bankrate.com/finance/debt/bad-money-habits-that-lead-to-debt-disaster-5.

aspx, retrieved on November 27, 2017.

© 2018 International Review of Finance Ltd. 2018296

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