Credit card rewards programs can provide us with a nice bonus when used carefully. The downside is they can often tempt us to overspend and any bonus that we get can be quickly erased. Another point to keep in mind is that if you can’t pay the balance in full, the interest costs will outweigh the benefit of the rewards program. Let’s take a closer look.
Let’s assume you have a cash back reward card that gives you 2% back on your purchases. If you normally spend about $20,000 per year on your card, and pay it off in full each month, you receive a cash back bonus of $400. But if for any reason you overspend by $400 you have erased any benefit of this bonus. This is particularly tempting when it comes to reward cards for airline tickets or points for gifts. We can often be tempted to spend extra in order to build enough points to qualify for that trip or food processor.
Rethink your reward strategy
Consider the length of time it will take you to earn the reward you want. If the trip you want to take costs 150,000 points and you earn 9000 points a year – it will take you 17 years before you have enough points. Let’s assume that you are paying $100 per year in annual fees. You spent $1,700 on annual fees – possibly the cost of an airline ticket?
Looking at a different scenario, let’s assume there is a $20,000 balance on your card and you only pay the minimum payment (let’s say 3%) each. If your interest rate is the typical 18%, it will take you close to 27 years to pay back the debt. By that time, you will have nearly doubled your balance because you have paid $19,800 back in interest. At that point you’re the one offering up rewards to your credit card company.
What’s in the fine print?
Some reward cards have annual fees that offset the amount of your reward. If your card has an annual fee is $100 and provides a cash back reward of 2% you would have to make $5,000 worth of purchases to break even. If you spend about $4,000 per year on your card you will receive $80 in cash back rewards but pay out $100, that’s not really a rewards bonus.
Watch for special conditions and limitations on your reward cards. Perhaps you can only book airline tickets during the off season. Your flight may be free, but you will likely need to pay tax or other fees, so factor that into your budget. Sometimes you may find your higher cash back offer ends after your reach a certain limit. Some cards offer 5% cash back until you reach $1,000 in purchases and then it drops to 1%. Fine print doesn’t stand out, but it’s still part of the story.
The bottom line
The more you spend, the more money creditors make. Creditors make money at every stage in the purchasing process. They make a cut at the point of sale (the store you buy from) and they make a cut through fees and interest collected from you the customer. The bottom line is to make informed decisions when choosing a rewards program. The benefit of your reward should always work for your budget, not against it.