Advantages & Disadvantages of Consumer Credit

Consumer credit allows people to purchase goods and services immediately and repay the costs over time. It offers consumers flexibility in spending and, in some cases, perks and rewards. However, consumer credit can also tempt some to spend beyond their means.

The single biggest advantage of consumer credit is the financial flexibility it enables. In the days before widespread access to credit cards and other consumer lending options, people often had to save for years to make major purchases.

If your car broke down or you needed a new refrigerator, it could hamper your ability to make ends meet. Credit allows consumers to spread out major costs over the course of months or years so they don't have to choose between buying a new transmission and putting food on the table.

The flexibility provided by credit also allows consumers to make timelier investments. If your house needs some roof repairs, for example, access to credit allows you to pay for them immediately. Without credit you might have to put money aside for months to complete the repairs. In the meantime, leaks might cause even more damage to your home.

Access to credit makes it easier to pay for basic needs and cover emergency expenses, but it also simplifies buying expensive products you might ​want​ but not ​need​. Psychologists have found that people often use credit unwisely due to natural human impulses.

Cornell University's Manoj Thomas, for example, studied the grocery shopping habits of 1,000 households over six months. He found that consumers who paid with credit cards were more impulsive in their purchases, loading their cards with junk food purchases and spending more frivolously. Thomas and his colleagues argued this was because the credit card shoppers felt less "pain of payment" than those who paid in cash. Cash shoppers understood they were spending money on a more tangible level, and that feeling moderated their spending.

In another study, researchers at Hong Kong University and the University of Colorado found credit cards with high limits change people's frame of reference for judging cost. Consumers with high credit limits, the researchers argued, tend to imagine their lifetime incomes will be very high, so they spend more freely.

Those with lower credit limits or no credit estimate their lifetime earnings will be lower, so they tend to spend less. A $10 meal at a restaurant feels expensive compared to the $20 in your wallet but cheap compared to a credit card with a $5,000 limit.

The problem with overspending is that ​it leaves consumers mired in high-interest debt​ that can cost them lots of money in the long run.

Consumers can earn substantial benefits by using credit if they use it wisely. Many department stores and car dealerships offer their customers advantageous financing options, including delayed payments and low interest rates. Credit cards often reward cardholders with cash-back offers, frequent flier miles and reward points.

For consumers who resist the temptation to overspend and pay off their credit accounts each month, these perks and rewards amount to free money. A credit card earning frequent flier miles, for example, could end up buying you a free vacation. But if you fall behind on the credit card payments, you'll pay much more in interest than the rewards are worth.

The interest rates on consumer credit are often staggeringly high and can force consumers to pay back several times the initial value of their purchases. The average annual interest rate on credit cards in the United States hit 21 percent in 2014 -- more than five times higher than the typical interest rate on a 30-year mortgage, which hovers around 4 percent. A $1,000 credit card purchase paid off over three years at a 21 percent interest rate ends up costing almost $1,400.