Do you ever wonder why so many people have a tendency to want to buy now and pay later? In most cases, we know in the back of our minds that we can’t afford to charge that expensive trip to Europe, especially with unemployment hovering around 10%. Still, we choose to do it anyway, hoping that the turnout will be a good one.
It’s sort of like signing up for a gym membership, knowing that you won’t be going everyday for the next two years. But we convince ourselves it’s a good deal with some fallacious math, and we do it anyway, don’t we?
This is the world of hyperbolic discounting, which is what credit card companies, and even gym memberships, use as their most common marketing tactics. But what exactly is it? The easiest way to break it down is to say that it’s the concept that people tend to want things now rather than later, even when waiting would yield a much better payoff. Essentially, we’re not very patient, and we’re wiling to pay a premium for our impatience.
What effect does this have on credit cards?
A 1994 study by Green, et al exposes how this concept shows itself in people’s buying habits. In the study, people were given the option of choosing between getting $50 today or $100 a year later, and most chose to get the $50. Why do you think? Our minds are programmed to want instant satisfaction, so we mentally discount later consequences. Effectively, when we estimate the likelihood of something happening in the future, or the amount of satisfaction it will bring us, we skew way beyond what’s truly rational. This is known as behavioral economics, since it doesn’t fall within the standard economists’ views of people being robots that are trying to optimize personal wealth with perfectly cool heads.
Prime examples of this are credit card fees and interest rates. A lot of folks know that if they use their credit card for $1,000 worth of purchases, and then make minimum payments for that balance, it will take about 106 months to pay it off with a 15% interest. Of course, they know deep down that they will end up paying a lot more than what they wanted to (which according to bankrate.com would be around $1,700). With hyperbolic discounting, we only see the short-term benefits vs the long-term repercussions they’ll have to endure later on.
This is one of the reasons why people tend to sign up for high interest rewards credit cards that have overpriced annual fees. All consumers tend to see are upfront promises like 1% cash back, which causes them to spend more money in order to receive that monthly bonus. Of course, no one is paying attention to the accumulating interest bill and the $100 annual fee, which likely wipes out any rewards earned over the course of the year.
Know yourself, and fight back.
Whenever you’re feeling the urge to grab freely for short-term gains, just keep in mind that credit card companies know you better than you do yourself. They know that you’re going to ignore the long-term consequences in order to get what you want today. This is how these executives are able to dine at exclusive restaurants and fly around on private jets, while we’re struggling with mounds of debt.
This post comes to you from the NerdWallet.com team of personal finance bloggers and experts in helping consumers compare low interest credit cards.