Posted by Lending Club :: May 15, 2008 @ 6:58 am

It’s long been known that using credit cards can cost you more, because of the interest and fees associated with their use. It also isn’t surprising that many people spend more when using credit. In some cases, though, the amount of the transaction may make cash a costlier option.

The reasons why we spend more when using credit are threefold. First, if we carry a balance on our credit cards, even spending the same amount will cost more using credit because of the interest we pay on the purchase. Second, the abstract nature of using credit disconnects us from the pain of spending cash. We may not consider what we’re spending because a swipe of the credit card for an expensive purchase is just as easy as for an inexpensive one. Third, using credit allows us to make purchases that we wouldn’t be able to afford otherwise. Many of us have higher credit limits than cash available for purchases, so it follows that using credit may lead to added spending.

The other side of the equation is the phenomenon that I’m sure we’re all familiar with. Once we break a large bill, it seems like the change we receive quickly gets spent. I can walk around with a twenty-dollar bill in my wallet for weeks at a time, but once it’s broken, the tens, fives, or singles that I get back seem to quickly disappear. If you carry a balance on your credit card, then making small purchases with your card could get very expensive due to the interest charged on those purchases. But if you’re like me and pay off your balance every month, you might be better off charging small purchases to avoid breaking large bills. I have gotten so used to this practice that I hardly even carry cash anymore. Again, this only works if you pay off your balance in full every month.

When budgeting, many people focus on minimizing either the small recurring expenses (like a daily coffee) or the large expenses (like high interest credit card debt). Both are important and reducing both types will prove to be the most effective. In a similar way, how we spend more may vary depending on the amount of the transaction. Some people may be better off always using cash, while others may find a mix of cash and credit to be the best fit.

Which causes you to spend more in each scenario?