Are rewards cards really that rewarding?
By Eva Norlyk Smith Ph.D.
April 7, 2014
I am looking at rewards credit cards, and there's some pretty tempting stuff out there for travel and cash back. What I don't get is how banks can offer all that free stuff and still make money. It seems as though there's got to be some catch. Can you really make money off these cards through cash back or free tickets? I want to sign up and get some rewards, but if there is some kind of trick I don't know about, I'll stay away. –Cathy
You know the saying: “There's no such thing as a free lunch.” In the short term, yes, banks offer some pretty attractive rewards benefits. In the long run, most people end up spending more than they earn in rewards on credit card annual fees and interest charges. Plus, banks also earn a small fee from merchants each time you use your credit card, which essentially cancels out the bank's costs for the rewards issued.
Also, from the bank's perspective, it's a marketing investment that pays off in the long run. For large banks, rewards credit cards are a great way to attract customers who might open checking or savings accounts, or apply for mortgages or car loans.
That said, there are smart ways to use rewards cards, and there are, frankly, some pretty dumb ways to use them, because, as you suspect, there are catches. However, if you stay clear of those catches, you can earn some pocket money with rewards credit cards.
Here's what to avoid:
High interest rates
Rewards credit cards typically come with much higher interest rates for purchases. For example, the average interest rate for low-interest credit cards is around 11 percent. For cash-back cards, rates average over 16 percent, and, in reality, many come with higher rates than that, around 20 percent or higher.
How to avoid it: The interest rate doesn't matter if you make payments within the interest-free grace period each month. Simply pay off the balance in full each month by the due date, and you will never pay a penny in credit card interest.
But beware: You have to pay off the entire statement balance before the due date. Make a partial payment even one month, and you will pay interest on the full balance until you reset the entire account balance to zero.
Many rewards credit cards come with annual fees, ranging from a modest $59 to more than $450, with most fees falling in the $75 to $100 range. In most cases, the annual fee is waived the first year, so it's easy to overlook when it kicks in. It is automatically withdrawn from your credit card, so unless you study your statement each month, you could overlook the charge.
Rewards cards with annual fees offer the best sign-up bonuses and higher rewards, so it's easy to get lured in. But if you do the math, that annual fee makes rewards earnings far less attractive. For a rewards card with an average 1 percent cash back earnings and an annual fee of $100, for example, you'd have to spend $10,000 on the card each year just to accumulate enough rewards to earn back the annual fee.
How to avoid it: Fortunately, this catch can be avoided. Stay away from the lucrative sign-up offers of cards with annual fees, and get a no-fee rewards credit card. Most rewards cards with an annual fee also have a no-fee version that is almost as attractive.
So, while there is no free lunch, with the right rewards card, you can enjoy a heavily discounted one. Bon appetit!
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