Credit Card Rewards

I meet a lot of people who talk about credit card rewards like they are the greatest thing since sliced bread. They talk about using them to see every country in the world. I also talk to people who use their credit card to pay for everything, just to rack up more and more rewards. So what are rewards and how do they work?

What Rewards?

Many credit cards offer some sort of reward incentive and it isn’t difficult to find one that sounds impressive and make you want to sign up. The way rewards work is your credit card company will give you some return on the purchases you make. Below are some examples:

• Discover It

  • 1% cash back on all purchases
  • 5% cash back on select bonus categories

• Bank of America’s BankAmericard Cash Rewards

  • 1% cash back on every purchase
  • 2% cash back on grocery stores & wholesale stores
  • 3% cash back on gas

• Delta SkyMiles

  • 1 airline mile on every dollar spent
  • 2 airline miles on every dollar spent with Delta

• Disney Visa Card

  • 1% in Disney Dream Reward Dollars on all purchases

Once you have racked up enough points/dollars/miles you can then redeem them for goods or services. For example: with the Discover It card you can trade 40 Cashback Bonus Dollars for a $50 Bath & Body Works Gift Card. The Disney Visa Card lets you swap 22.95 Disney Dream Reward Dollars for a DVD at the Disney Store. Doesn’t that sound amazing? Just for using your credit card you are able to get FREE stuff.

What’s The Catch?

There is no such thing as a free lunch, and therefore, if the credit card companies are giving you free stuff they have to make the money up somewhere else.

Each credit card company works a little different, but overall there are three major ways they pay for these rewards:

Sponsorship:

Some credit card companies work out sponsors to offer rewards. These sponsors then pay for the opportunity to offer rewards. This is a mutual partnership where the credit card company makes money from the sponsoring company buying participation, while the sponsoring company gains attention and hopefully business from offering the rewards.

Annual Fee

Some credit cards offer an annual fee to cover the perks of a credit card and this includes the rewards. American Express is most known for their exclusivity and annual fees. The fees on credit cards can vary greatly, but some can be greater than $100 per year.

High Interest Rates

A credit card’s interest rate can also vary greatly and in many cases depends on your credit score. However, another major factor can be the rewards that are offered. It is nearly impossible to find a low interest rate on a credit card with great rewards, even if you have terrific credit.

Are Rewards Good or Bad?

I personally love credit card rewards programs and have greatly benefited from them. But I am not your typical credit card user. I pay my credit cards off in FULL every single month, therefore, I do not pay anything in interest. I also do not use any credit cards that require me to pay an annual fee.

Falling into the credit card rewards trap can be very dangerous. People tend to get hooked on obtaining more rewards. They begin to spend more and use their credit card for everything. This is a terrible idea. As part of the Financial Freedom Journey it is important to budget your money and ensure that your expenses are less than your income. Many people “chasing” the rewards blow up their budget and overspend.

If you are taking out a credit card with an annual fee then no matter what the rewards are, you are throwing money away. A credit card with an annual fee is never a good financial decision. Furthermore, you might not even make the annual fee back in rewards to even make it worthwhile.

If the credit card has a higher interest rate and you are not paying your credit cards off every single month then the increased interest rate for the rewards is most likely costing you money. The difference between an interest rate of 3% and 18% can be incredible and easily wash away any returns on the rewards you are getting.

Finally, you will not get rich from credit card rewards. It just won’t happen and stop believing the marketing hype that you will. Below is a breakdown of the rewards for each of our sample credit cards if I spend $1,000 in a month:

• Discover It

  • $10 in rewards if a normal purchase
  • $50 in rewards if a bonus category

• Bank of America’s BankAmericard Cash Rewards

  • $10 in rewards if a normal purchase
  • $20 back if a grocery store or wholesale store purchase
  • $30 back if gas

• Delta SkyMiles

  • 1,000 airline miles if a normal purchase
  • 2,000 airline miles if spent with Delta

• Disney Visa Card

  • $10 in Disney Dream Reward Dollars

In this sample Delta looks like the best reward, but a flight takes a lot of miles. For example a flight from New York City to Orlando, FL for Valentine’s Day cost 27,500 miles + $11.20. Therefore, to redeem that fare you would need to spend more than $27,000 on the card and then you would still need to shell out $11.20.

If you pay off your credit card every single month, you do not have an annual fee, and you do not increase your spending then credit card rewards can be a great bargain. But, if you are not, then avoid them because most likely they are costing you money and not saving you a dime.

Your Financial Freedom Partner,
Joel Parker