RDP 2018-11: Consumer Credit Card Choice: Costs, Benefits and Behavioural Biases 4. Estimating the Net Monetary Benefits of Credit Card Holding

4.1 Components of Net Monetary Benefit

In the RBA's 2016 Consumer Payments Survey, respondents were asked to identify the card features that were most important in their decision to hold a credit card at all, and then asked about the features that were most important when they chose their current main credit card. I use this information to identify which features to include in the calculated net monetary benefit.

In their initial decision to hold a credit card, consumers clearly valued a wide range of features.^[15] Among the four most common reasons, two were monetary benefits – the interest-free period and rewards points – though a large share of consumers also valued non-monetary features (Figure 1). When asked to select the single most important reason for holding a credit card, three of the four most common responses were also monetary features – the interest-free period, rewards points, and the ability to borrow money and smooth spending. Most non-monetary features that cardholders valued were features that are now also available in debit cards (for instance, convenience, widespread acceptance and the ability to shop online).^[16]

When asked about the reason for choosing their main card, monetary features were somewhat more prominent. The four most commonly selected monetary features were fees, rewards points, the interest rate and the interest-free period (Figure 2).^[17] A relatively small number of respondents were motivated by other features that may also carry a monetary value, such as a sign-up offer, a balance transfer deal, or insurance and concierge services. The most common non-monetary factor that influenced card choice was that it was offered by the respondent's main or preferred bank.^[18]

This paper provides a first estimate of the distribution of the net monetary benefits that consumers receive from holding a credit card, based on the value of the four card features that respondents cite as most important. However, these are estimates only, as they do not reflect other monetary costs and benefits, such as the value of any insurances provided by the card, or the value of any sign-up offer or balance transfer deal that respondents may have received.

4.2 Calculation

Based on the above information, the four features that respondents identify as most important in their choice of card, and that carry a monetary cost or benefit, are the annual fee, the rewards program, the interest rate and the interest-free period. To estimate the net monetary benefit of cardholding, I sum the annual value of these components for each respondent:

The value of each component varies depending on the features of the particular card that the respondent holds (for instance, the generosity of the rewards program, the annual fee and the length of the interest-free period), and on the respondent's behaviour (their total spending, how they redeem their rewards points, their use of the interest-free period, the size and frequency of interest payments, and whether and how they would borrow money if they did not have a credit card).

The value of rewards points is based on an estimate of the number of points that each respondent accrues, multiplied by an estimate of the value of each point. The total number of points depends on the annual amount that the respondent spends on their credit card and the number of points their card accrues per dollar spent. The value of each rewards point varies depending on the card, and on how each respondent uses their points. For most respondents, I estimate a ‘conversion rate’ of rewards points to monetary value based on redeeming their points for a $100 gift card. For those who state they use their rewards points for flights, I base the estimate on the price of flights along major routes around the time of the survey, instead of the $100 gift card.

The value of annual fees is based on the fee advertised around the time of the survey. The advertised fee is scaled down by half if respondents stated that their annual fee had been discounted in the past year, and set to zero if they stated that it had been waived.

The value of the interest-free period is based on the respondent's alternative interest rate (e.g. savings deposit rate, mortgage rate, personal loan rate), multiplied by total annual spending and by the length of the interest-free period that the cardholder uses. This length is estimated based on the card's interest-free period (assuming that, on average, spending takes place in the middle of the statement month), and the portion of the interest-free period that the respondent reports that they generally use (for instance, respondents may pay off their card after each purchase, in weekly or fortnightly instalments, or on the due date).

The value of interest paid is reported by respondents who had accrued interest charges in their most recent monthly statement (and is equal to zero for all other respondents). They were asked to enter the value of new interest charges from their most recent monthly statement. This value was then scaled up, for an annual estimate of interest charges; it is multiplied by twelve months for respondents who state that they always repay the monthly minimum and nothing more, multiplied by three months for respondents who report that they sometimes pay off their balance in full, and sometimes not, and treated as a one-off (multiplied by one) for respondents who state that they always pay off their balance in full.

For each cardholder, the calculated net monetary benefit is based on the credit card that they use most often (their main credit card). For about 60 per cent of cardholders, their main credit card was the only card that they held, but some respondents held multiple cards.^[19] Respondents with multiple cards are a heterogeneous group. Some appear to hold multiple cards because they are motivated by the rewards points that those cards offer, while others may hold multiple cards because they have reached the borrowing limit on their first card. These different types of respondents may use their main card in a different way from their second or third card, meaning that my estimated net monetary benefit may not fully reflect their overall credit card use patterns.

Importantly, my calculations include only the amount paid or received from owning a credit card, and do not take account of the respondent's opportunity cost or outside options. For instance, some respondents who use their card to borrow may face outside options – such as payday loans – from which they would likely incur higher net losses.

While the survey data provide detailed information, my calculations do require a range of assumptions and simplifications. Importantly, the elements of the net monetary benefit are based on spending and interest charges during a single month, but are scaled up to be expressed in annual terms. I apply a seasonal factor to these estimates to control for any month-specific effects.^[20] In addition, card features are based on advertised conditions. Some respondents may have faced different fees or rates to those advertised for all or part of the year, and cardholders may incur incidental benefits or fees (such as late payment fees) that are not included in my calculations.

Full details on how each component is constructed, along with analysis of the sensitivity of my estimates to varying assumptions, are available in Appendix B. While different assumptions affect the value of the average net monetary benefit, the overall distribution of costs and benefits does not appear overly sensitive to my assumptions.

4.3 Comparison with Aggregate Measures

While my estimates of net monetary benefit vary across consumers, they suggest that, on average, consumers receive a net monetary benefit from their card that is not significantly different from zero.^[21] This average estimate is different from the net cost or profit to card issuers, most notably because my calculations are based on the value of the interest-free period to the consumer, and not the cost of funds to the issuer.^[22] My calculations also exclude a range of ad hoc fees that respondents may incur (such as late payment fees, over-limit fees and international transaction fees), and are based on the assumption that consumers with rewards credit cards use all of their rewards points. This assumption is likely to overestimate the value that consumers receive from their rewards program.^[23]

I do not have a benchmark to compare my overall estimates, but I can compare two components of the net benefit with published aggregates: annual fees and aggregate credit card spending. Both comparisons suggest that my estimates are a reasonable approximation of the population average, but appear to be a slight overestimation of the net monetary benefit that the average cardholder receives.

The estimate of average credit card annual fees used in my analysis ($70) is somewhat lower than that from the RBA's 2016 survey of bank fee income ($137; see Fitzpatrick and White (2017)).^[24] This difference may reflect over-reporting of the incidence of waived or discounted annual fees by survey respondents, or it may be that my sample includes a disproportionate share of consumers who had their annual fees discounted or waived. My decision to exclude respondents with very high annual fees (of $1,000 or more) from analysis also contributes to the difference. As an alternative to my preferred estimate of annual fees, I re-estimate the average annual fee including these very high-fee cards and using the annual fees advertised for the cards that respondents held, rather than adjusting for self-reported fee waivers or discounts. In this alternative measure, my estimate of respondents' annual fees increases to $130, closer to that of Fitzpatrick and White. However, I do not use this alternative measure in my analysis; I exclude very high-fee cards as I cannot capture the value of monetary benefits associated with these cards. In addition, the value of annual fee discounts and waivers may be important factors in respondents' choice of card; disregarding this information may cause bias in the opposite direction.

The value of credit card spending for each respondent is used as an input to the estimated value of rewards points and of the interest-free period. Higher spending leads to a larger benefit in both components. On average, credit card holders in the Consumer Payments Survey reported spending around $22,000 on their main credit card each year, which, based on the ratio observed in the survey data of main card to total credit card payments, suggests average annual credit card spending of $30,000. This is somewhat higher than an aggregate estimate of consumer credit card spending based on the RBA's monthly retail payment statistics, which suggests credit card purchases totalled around $24,000 per year per cardholder. As a result, my method is likely to overestimate the value cardholders receive from rewards points and from their interest-free period.

Footnotes

See Doyle et al (2017) for analysis of how these preferences differ by age group. [15]

Respondents were able to select from a list of reasons, or enter their own reason under the ‘Other’ option. Of those who selected ‘Other’, the most common reason was that they hold a credit card in case of emergencies. [16]

The monetary value of the interest-free period is the benefit cardholders would receive from maintaining funds in a savings account (to earn interest) or in a mortgage offset account (to reduce their interest liability) rather than paying for their purchases upfront. This value varies across individuals, and would be higher for those who typically spend more on their card. [17]

This preference may itself reflect a behavioural bias. However, most banks offer a range of credit card options, so a preference to remain with a single bank is unlikely to affect the features of the card that respondents choose. [18]

One-quarter of respondents held two cards, and 13 per cent held three or more. The vast majority (three-quarters) of credit card purchases recorded in the 2016 Consumer Payments Survey were made using respondents' main card. [19]

The seasonal factor is derived from the time series of total personal credit card spending in the RBA's monthly retail payment statistics. [20]

The mean net monetary benefit is $2, with a 95 per cent confidence interval ranging from –$66 to $69. The median is $9. [21]

As a rough approximation, if we instead replace the value of the interest-free period to consumers with the overnight interest rate (as a proxy for bank funding costs) and adjust for non-use of rewards points, the average falls to a net loss to cardholders of $40. [22]

Over 10 per cent of rewards card holders stated that they had never redeemed their rewards points before (see Appendix B). [23]

Note that many credit card issuers are not banks. Fees on cards issued by non-banks are not included in the RBA survey of bank fee income, but they are included in the Consumer Payments Survey. [24]