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.
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.