We’ve all seen those bold proclamations of 5% cash back rewards from credit card companies. It’s enticing to think you could raking up the big bucks by simply swiping your credit card everywhere you go. It would only take $1,000 of spend in a month to get $50 back. Doesn’t sound like a bad deal. Except it is, because you need to be wary of any cash back rewards above 2%. As a rule, banks don’t like to lose money and legitimately offering 5% back would make them bleed out cash to gleeful consumers.
Why do banks offer cash rewards?
Every time you make a purchase at a store, the store has to pay the financial institutions a portion of what you paid, usually around 2%. So when you spend $1,000 at Best Buy, around $20 of that goes to the Visa/MasterCard/American Express and your bank. It’s called an ‘interchange fee‘ and your bank gets the biggest cut of that.
Since banks are competitive, and fighting for the pool of the most credit-worthy customers, they offer some of that interchange fee back in the form of rewards on cards for people with good credit. If you’re a diligent credit card user, and pay in full each month, then you should take advantage of the banks clamoring to offer you rewards in exchange for using their product.
What are the gotchas?
Banks are willing to give that money back because they are betting on two things.
- you spending your money on their card, so they can earn more of those interchange fees from stores and merchants.
- some people slipping up, so they can collect interest charges.
Even the most conscientious credit card users — looking at you Mr. 800 Credit Score — sometimes end up carrying a balance and making a minimum payment for a few months. Usually it’s the consequence of something out of the ordinary, like a family emergency or life event like a wedding. That means the bank gets to collect interest on what you’ve spent, and that’s the biggest money maker for them, with interest rates often 15% or more.
The easiest way around that is to set your rewards card to auto-pay in full each month. As long as there’s enough in your checking account to cover your charges each month you’ll never get hit with interest. Make sure you have enough in your account, otherwise you could get slapped with an overdraft fee.
Of course, we all have the best of intentions and no one actually plans to go into credit card debt. If you hit a month where you can’t pay your card bill in full, immediately start shopping for a balance transfer offer (usually around 0%) or personal loan to minimize the interest impact.
You should earn more than 1%
If you are responsible with your credit you deserve to be rewarded, so don’t just settle for the 1% that most cash rewards cards offer. You’re leaving money on the table. A lot in fact.
The average family spends about $1,800 a month on things that can be placed on a rewards credit card instead of writing checks, using debit cards, or paying cash.
A 1% rewards card will earn $180 in annual cash back, a nice sum considering some users won’t even be raking in that extra amount. But why settle for nice? There some no-annual-fee options that will earn you 1.5% – 2% on all of your spending.
That’s an extra $100-$200 a year you’re leaving on the table.
But beware of earning more than 2%
Because the banks only make around 2% on those interchange merchant fees it’s not viable, nor lucrative, for them to offer you much more than 1.5-2% rewards across all of your spending.
Oddly enough, you’ll often see cards offering big category bonuses like 5x on gas.
Those offers always have fine print associated with them that attempt (and usually succeed) to reduce what you really earn.
The fine print comes in two flavors:
- A cap on what you can earn
- A mechanism that hopes you forget something
For example, a card may offer 3x on grocery spending, but only up to $6,000 a year. That works out to $500 in spending a month, which is a lot, but many of us spend more than that. So you’re really not getting 3x on all of your grocery spending, just some, and only 1x on the rest.
Banks also utilize the rotating categories. Some cards offer a bonus on dining in certain quarters, or they may ask you to register for the category bonus each quarter. Both of these are bets by the bank that you’ll be forgetful.
The bank is hoping you whip out its card for all of your spending, thinking you’ll get the big bonuses on all of it. But in reality you’re not, and you are often better off with a straight 1.5 or 2% cash rewards card.
The easiest way to see what you’ll really earn from a card is to put your monthly spending habits into our Cash Back tool. It will show you the cash back rate you’ll earn, factoring in all of those complicated caps and category bonuses.
It doesn’t pay to be loyal
Of course you can earn more rewards by carrying more than one card around, choosing the one with the best category bonus for your spending.
But the biggest extra rewards come from sign on bonuses when you open up a new card, often $100 – $200 for spending a small amount on the card upfront, on top of the rewards you’d earn otherwise. For example, a card that earns $200 cash back when you spend $1,000 on it within 3 months is really offering you over 20% cash back on that $1,000 in spending.
However, you should only take advantage of these offers only if you’re organized and either set your new cards on auto-pay or are incredibly diligent about paying your bills on time.
You’ll maximize your rewards by applying for a new card with an intro offer at least once per year, taking advantage of the latest intro offers. Then deciding if that new card is a better fit for your ongoing spending, or continuing with your favorite card.
Your credit score gets hit about 3-5 points from new card applications, but that only stays on your report for 12 months, and many times your score will ultimately improve because you’re handling new, bigger credit lines responsibly. Just be careful not to open and close too many cards all at once.
One evaluation a year could equal an extra $200
Our Cash Back tool always has the latest deals available. Get in the habit of reassessing your rewards at least once per year, and you could add an extra $200 or more to your cash each year.