Understanding how consumers use credit cards requires recognizing that they function as two distinct financial tools, according to recent economic research. This perspective illuminates how different users manage their credit and the broader implications for the U.S. economy.

The research highlights a importent division among U.S. credit card holders. While approximately 80% of American adults possess a credit card, their usage patterns diverge sharply, creating two distinct groups: “transactors” and “revolvers.”

Roughly half of U.S. adults with credit cards use them for regular purchases, diligently paying off the balances each month and avoiding interest charges. These individuals, frequently enough referred to as “transactors,” treat their credit cards as a convenient payment method, similar to a debit card but with added benefits like rewards and fraud protection. The other half, known as “revolvers,” carry balances, financing purchases over time and incurring interest charges. This interest averaged around 15% between 2001 and 2019 but has since surged to approximately 22%, reflecting broader economic trends and tighter monetary policies implemented by the Federal Reserve.

A key finding reveals a parallel relationship between credit limits and debt for both types of cardholders. “For both kinds of cardholders, when their credit limits went up or down, so did their credit card debt,” the study notes, presenting a puzzle in consumer financial behavior. This suggests that credit limits may influence spending habits irrespective of whether someone typically pays their balance in full.

The study, published in the Journal of Monetary Economics, proposes a model to explain this behavior. For “revolvers,” available credit serves as a safety net against unforeseen financial challenges, such as unexpected medical bills or car repairs. An increase in credit limit is perceived as increased wealth, leading to higher spending. This, in turn, increases debt, perhaps reducing lifetime consumption. The researchers found that “when their credit increases, they effectively become wealthier and so they spend more.” This behavior can be particularly pronounced during economic downturns when individuals may rely more heavily on credit to maintain their standard of living.

Conversely, “transactors” tie their spending more closely to their current income. As income rises, so does their spending and credit card usage, leading to a corresponding increase in their credit limit. “Both groups have stable patterns of credit card use,but for very different reasons,” the research explains. For example, a young professional who receives a promotion and a salary increase may also see their credit limit increase, allowing them to make larger purchases and accumulate more rewards points, which they then pay off in full each month.

Credit plays a crucial role in providing access to funds, especially for young adults. Credit limits tend to increase significantly between the ages of 20 and 30, rising by approximately 400%, and continue to grow, albeit at a slower pace, after age 30. This early access to credit can be pivotal in establishing financial independence, allowing young adults to rent apartments, finance education, and build a credit history. However, it also presents the risk of accumulating debt early in life, which can have long-term consequences.

Despite ample increases in credit availability early in adulthood, individuals tend to maintain a stable credit utilization rate as they age, with only a gradual decline after age 50. This suggests that spending habits and financial management styles are established early and persist throughout life. As an example, someone who consistently uses 30% of their available credit in their 20s is highly likely to maintain a similar utilization rate in their 40s and 50s, even as their income and credit limits increase.

The research indicates that someone using about 40% of their available credit in 2004 likely maintained a similar utilization rate in 2019,even with increases in income and credit lines. This consistency underscores the ingrained nature of credit management behaviors. This highlights the importance of establishing good credit habits early in life, as these habits are likely to persist throughout adulthood.

While the temptation to accumulate debt and default might seem to increase with higher credit lines,the study found the opposite: default rates decrease as consumers age. this suggests that unexpected events, rather than increased credit availability, are the primary drivers of debt defaults. The model revealed that “most peopel default on debt because of unexpected events beyond their control.” These events can include job loss, medical emergencies, or divorce, which can significantly impact an individual’s ability to repay their debts.

The study leverages comprehensive data from credit bureaus like Equifax,Experian,and TransUnion,encompassing all credit card debt associated with individual consumers. This approach contrasts with previous models that relied on data from individual credit card accounts, providing a more holistic view of consumer behavior. by analyzing data from all credit cards held by an individual, the researchers were able to gain a more accurate understanding of their overall credit usage and financial health.

A related study published in 2023 in the Journal of Money, Credit and Banking offers a method for identifying revolving behavior within credit bureau data, which typically does not explicitly report this distinction. This methodology enhances the ability to analyze and understand different credit usage patterns. This is particularly useful for policymakers and lenders who want to better understand the credit behavior of different segments of the population.

while acknowledging the existence of more than two distinct types of credit card users, the research emphasizes that categorizing users into these two groups simplifies the understanding of credit card use and consumption patterns. This categorization helps explain why individuals tend to maintain a stable utilization rate throughout their lives and how changes in credit limits can impact spending behavior. Though, it’s significant to recognise that this is a simplification and that individual credit card users may exhibit characteristics of both “transactors” and “revolvers” at different times in their lives.

Practical Implications and Recent Developments

The findings of this research have several practical implications for consumers, lenders, and policymakers in the U.S.

• For Consumers: Understanding your credit card usage patterns can help you make more informed financial decisions. If you are a “revolver,” consider strategies to reduce your debt, such as creating a budget, consolidating your debt, or seeking credit counseling. if you are a “transactor,” continue to use your credit card responsibly and take advantage of rewards programs.
• For Lenders: The research suggests that lenders should consider an individual’s overall credit behavior, rather than just their credit score, when making lending decisions. Lenders may also want to offer different types of credit products to “transactors” and “revolvers,” tailored to their specific needs and risk profiles.
• For Policymakers: The research highlights the importance of financial literacy education, particularly for young adults. Policymakers may also want to consider policies that encourage responsible credit card use and discourage excessive debt accumulation.

Recent developments in the credit card industry include the rise of fintech companies offering choice credit products, such as buy-now-pay-later (BNPL) services. These services can be convenient for consumers, but they also carry the risk of accumulating debt quickly. It’s important for consumers to understand the terms and conditions of these services before using them.

Furthermore, the Consumer Financial Protection Bureau (CFPB) is actively monitoring the credit card industry and taking steps to protect consumers from unfair or deceptive practices. The CFPB has recently issued guidance on credit card late fees and is considering new regulations to promote openness and competition in the credit card market.

Addressing Potential Counterarguments

While the research provides valuable insights into credit card usage patterns, it’s critically important to acknowledge potential counterarguments and limitations.

One potential counterargument is that the categorization of credit card users into “transactors” and “revolvers” is too simplistic and does not capture the full complexity of individual financial behavior. While this is a valid point,the researchers argue that this categorization is useful for understanding broad trends and developing effective policies.

Another limitation is that the research relies on data from credit bureaus,which may not capture all aspects of an individual’s financial life.For example,the data does not include information on cash transactions or investments. However, credit bureau data is still a valuable source of information on credit card usage and debt.

it’s important to note that the research is based on historical data and may not accurately predict future trends. Changes in the economy, technology, and consumer behavior could all impact credit card usage patterns in the future.

Despite these limitations, the research provides a valuable framework for understanding credit card usage patterns and their impact on personal finances and the U.S. economy. By understanding these patterns, consumers, lenders, and policymakers can make more informed decisions and promote responsible credit card use.

Consider your credit card habits to be an investment, and use your card to your best advantage. dr. Vance, a financial expert, suggests several key steps to optimize credit card usage:

• Self-Assessment: “Honestly assess whether you’re a ‘revolver’ or a ‘transactor’,” Dr. Vance advises. Self-assessment is crucial for understanding your current state.
• Budgeting: “Create and stick to a budget. Know where your money is going,” he emphasizes.
• Emergency Fund: “These funds are essential. Then, any financial setbacks will be easier to overcome.”
• Monitor, Monitor, Monitor!: “Check your credit report regularly for any errors or fraudulent activities.”
• Financial Education: “Read books, take online courses, or work with a financial advisor to expand your financial know-how.”

The main takeaway is to understand yourself what kind of a card user you are and get the best out of the credit you have!