Stern Advice: Paper or plastic? How to pay for holiday gifts

WASHINGTON Wed Dec 7, 2011 1:55pm EST

WASHINGTON Dec 7 (Reuters) - Scott Schuh is a Federal Reserve Bank economist who spends his days studying the myriad ways consumers pay for their purchases. After a recent review of his research, he did something surprising - he gave up his rewards credit cards, and now pays for everything with a debit card.

Why? Chalk it up to a highly developed social consciousness. Schuh says rewards credit cards generate a "reverse Robin Hood effect" in which shoppers who don't qualify for the premier cards subsidize the usually well-heeled folks who do. That subsidy occurs when merchants charge everyone higher prices to cover their costs of accepting rewards cards.

Schuh gives up those rewards, usually in the neighborhood of 1 percent or more, to feel better about his transactions and how they contribute to the greater good.

That adds a whole other level of analysis and introspection to the already confusing issue of how we pay for the goods and services we buy. Schuh says it has gotten way more complex than it used to be, with the number of available payment instruments doubling in the last 20 years.

With the addition of mobile phone payments, consumers now have 10 different ways to pay at their disposal, including credit cards, checks, bank transfers, debit cards, prepaid cards, online payment intermediaries, online bill pay and - lest we forget - cash. It's no wonder that more and more shoppers are simply using cash.

Cash is the most rapidly growing method of payment, according to Schuh's research: In 2010, 29 percent of all payments were in cash.

The way we pay is rapidly changing, with new payment mechanisms launched almost daily. Retailers are expected to start offering discounts to shoppers who use less expensive payment methods; by next year we may be seeing cash prices as well as credit prices for many items. Phones are becoming wallets, holding codes that link directly into checking accounts and credit card numbers. Credit card rewards may disappear altogether, some observers suggest, once users have to pay for them directly.

But for this holiday shopping season, decisions have to be made every time to click "place order" or carry an item to the register. Here's how to pay now.

-- Charge it. Qualms about systemic fairness aside, a rewards credit card is still the best way to pay for purchases, says Ed Mierzwinski of the National Association of State Public Interest Research Groups. You'll get cash (or miles) back on everything you buy, and - more importantly - all the guarantees and consumer protections that come with a credit card. In addition, you'll get 25 days or so before the bill arrives.

If, like Schuh, you're bothered by the unfairness of rewards cards, just use a regular, non-reward card, says Mierzwinski. And, if you have a troubled credit history and can only get a secured card? Use that. Because it won't allow you to spend more than you have on deposit, it will help you stick to an affordable budget, while you rebuild your credit reputation.

-- Use a prepaid card. These run the gamut from Starbucks gift cards to Visa and MasterCard issued cards that look like credit cards, work like cash, and carry extra fees. They are safer than carrying cash; if you register your prepaid card and lose it, you may be able to protect its value. You can actually get most of your holiday gifts at a discount if you spend gift cards bought at a discount through an exchange like the one run by Card Hub (). Do compare prepaid cards before choosing one. Some are reasonably priced and convenient; others have fees that are "outrageous," says Mierzwinski.

-- Leave the debit card at home. Debit cards are scary; so much so that Mierzwinski refuses to use one. The main difference between the debit card and the credit card is this: If bad charges show up on your debit card, the money comes out of your checking account first, and you have the burden of proving somebody (like your bank) should put it back. That's a significant burden.

-- Don't bother with the special online cards. You can use your regular credit card online, says Mierzwinski. "I don't bother getting unique virtual credit card numbers and that other rigmarole," says Mierzwinski. If your card number gets stolen online, you have the same protections you would if the plastic gets lifted out of your pocket: You won't be responsible for fraudulent charges. You can get extra deals on many holiday gifts by buying them online through the shopping portal run by your credit card issuer.

-- Mobile payments? Still not ready for prime time. Although CNBC is reporting that 16 percent of shoppers have used their phones to pay for purchases this shopping season, some experts think there are still many unanswered questions about paying by phone. "It's still rated the least secure way to pay," Schuh says. Mobile phone payments aren't really wholly new ways to pay: If you use your phone, you're still basically authorizing a withdrawal from your checking account or an advance on a line of credit. If you want the convenience of paying by phone, choose a credit-linked mechanism and not one that hits your checking account. (The Personal Finance column appears weekly, and at additional times as warranted. Linda Stern can be reached at linda.stern(at)thomsonreuters.com)