The following guest post is by Kevin Fleming of CreditShout.
Rewards credit cards look like a great deal on paper. Who doesn’t want to earn points for purchases? Who doesn’t want to get money back from their credit card? It all sounds good, and for some people, it is. But the truth behind rewards credit cards is that they aren’t always the best idea for everyone, and if you don’t know how to handle them, they could turn into really bad ideas.
What is a Rewards Card?
Each time you use your credit card to make a purchase, a rewards card will “reward” you with points based on how much you spent. Those points can then be redeemed for various perks, like discounts on travel, cash back percentages, and more. Some rewards cards are centered on certain types of purchases, i.e. you will only receive points for purchasing travel-related things, and you earn frequent flier miles as points in return. The terms of each card varies, but for the most part they all operate pretty much in this way.
The Dangers of Rewards Cards
So how does it go wrong? The problem is that a rewards card is giving you a service, and like with any other service, you’re paying for it. Your rewards card, while giving you plenty back in the shape of points and discount percentages, is actually costing you money, too.
Rewards cards often have high interest rates compared to others available on the market for comparable credit scores. Often, only those with good credit can get rewards cards at all, and even then, the interest percentage is high enough that you should always pay off your balance each month. Carrying a balance adds up really quickly, and soon enough it might reach a point where it would have been cheaper to buy your own perks.
[Kevin @ Invest It Wisely] This is why it is important to pay off your balance in full before your bill is due. I use reward credit cards myself to get Air Miles, and although the interest rate is high, I almost always pay off the bill before interest is due. If you find you are spending too much per month to pay off your bill in full, then you need to take a look at reducing your expenses.
When you are able to do so, credit cards can be a decent way of ramping up your rewards without paying a penalty for doing so.
Compare Carefully
There are different types of rewards cards, and while they’re all similar in how the program works, it’s still important to compare them. Some cards have restrictions you might not expect – like not paying you rewards until you spend $5,000, or handing out points that expire within a year. The important thing is to examine the list of rewards really carefully, because many of the ones that sound good, and that are used in the card’s advertising, are impossible to earn unless you spend a serious chunk of cash with the card.
It becomes especially important to compare if the card charges you an annual fee. Don’t pay for the service unless the extra rewards points really are worth it, based on what you spend. Otherwise, keep shopping until you find a free rewards card that won’t cost you money just for the privilege of being a customer.
[Kevin @ Invest It Wisely] Is purchasing a credit card more common in the U.S.? I personally don’t pay for any of my cards, and don’t see a good reason why I would. The companies already make plenty of money off of merchant fees and interest charges.
Proceed With Caution
Here’s the other part: don’t forget that rewards credit cards have a goal: to get you to spend more. Why else do certain rewards only become available when you earn a large amount of points by having spent a large amount of money? It’s like a “buy two get one” sale; you only meant to buy one, but since it gets you something free or cheap, you’ll buy two. The same can happen with a rewards card: if you’re within a few hundred bucks of a reward you want, you might find yourself actually jacking up the balance on your credit card on purpose. It sounds crazy, but it happens.
Don’t get the impression there’s anything wrong with rewards cards –there’s not, and for those with good credit scores, who can take advantage of the perks they offer, reward cards can potentially be a great deal. But if you’re blinded by a good deal, or just looking for a freebie, you should pass on the rewards cards. Nothing in life is free.
[Kevin @ Invest It Wisely] Well this is certainly a good point. There isn’t much value to the rewards credit card if you’re going to spend twice as much on things you don’t need, simply to get some points! Remember the opportunity costs of your purchases.
So, reader, what is your take on rewards credit cards? Do you use them? I personally use them, myself, but I limit myself to a couple of credit cards! I don’t spend a lot of money on discretionary items so I find it can get too much to keep track of otherwise.
Kevin Fleming runs CreditShout, a blog that reviews credit cards like Chase Freedom and promotes responsible card use.
I heart my reward cards! I never, ever carry a balance, and I get enough rewards that it pays for my Christmas shopping.
I have two cards, one is American Express Blue Cash, and I have a Capital One card that I use when a merchant does not take American Express.
However, if you do carry a balance, the rewards should be the least of your worries. You have much bigger problems then thinking about which card provides the best rewards.
Certainly, it can cost you… but it doesn’t have to. I recently switched and now I pay nothing, carry no balance, and get a dividend at the end of the year for using it. And, they give me weeks to pay… so I use their money. The “points” systems typically aren’t worth their weight unless you’re spending tremendous sums of money on it each month.
Reward cards are ok if you pay it off every month. I only use one credit card. I know this is not really optimal and I should use one more card, but we really try to minimize credit card usage these days. I have a bank card as a back up.
We use mostly use cash these days and I think we spend less overall.
I think that one has to be very, very careful with rewards cards. It’s all about keeping the eye on the prize, which for me is that far off vision of financial freedom….which means avoiding carrying debt…which means not carrying credit card balances….and also means not making repetitive unncessary purchases. This last step is where these cards can get people, one would think. It can become like a game, spending to earn reward points.
As long as one is disciplined and doesn’t let these temptations of rewards cards distract from disciplined spending, then it can be good to get something back. Nothing is free, I agree….but for the truly disciplined who don’t let rewards influence their spending even .001%, it’s better than not having rewards!
I just have one card – the capital one rewards card. I use it for all my everyday purchases and pay off every month. I can’t say that the 1% cash back is an incentive to spend more…but when there are high spending months (like around the holidays), I do scrounge around for extra cash and I love cashing in my rewards in.
My interest rate is indeed high, but it almost never impacts me.
If you carry a balance rewards cards are a terrible choice – better off with a vanilla credit card. Rewards cards have a higher interest that cancels out any potential reward you might get.
But for those who pay their balance in full, this makes sense. All my cards are rewards cards and I don’t even know what the interest rates are on these.
Hi Kevin, I have 2 credit cards and pay off in full every month. The rewards are nice as I usually choose gift cards to places I already shop! But in general, I’m not concerned with getting the “perfect” card. Too much work!
I only use cash back cards. Many benefits on reward cards never get cashed in. I’d rather have cash in hand to spend or save the way I see fit. I’ve got my spending habits down to the point the cash back pays off a full month’s bill so effectively I only get a credit card bill 11 out of 12 months.
Thanks for stopping by to comment, everyone. I think that so long as your finances are in order, then rewards cards can be a useful tool. Otherwise, you might end up with burnt fingers!
Great post. Keep up the good work!