Are rewards credit cards worth it?

As tempting as free traveling miles might be, the answer is no, and we are going to show you why. The main reason is: you are the one paying for your own rewards. The card issuing company is not giving you a freebie. In this article, we are going to explain how it is that you end up paying for these rewards.

You might feel drawn to using rewards cards because of all the advertised benefits. Not doing it might feel like “leaving free money on the table”. The way it works seems simple: you spend what you always spend and you get something extra in return. The credit card rewards might be traveler miles, free access to credit scores, a statement credit, points out of each dollar you spend, or even 2% in cash back rewards.

But in this article, you will see that credit card rewards aren’t all they’re cracked up to be, and in fact, they are costing all of us a lot of money. First, let’s see what you’re paying for. 

Types of rewards credit cards

There are three main types of reward credit cards. Most cards will offer one of these benefits or a combination of them.

1. Cash-back credit card

Most cash-back credit cards use a straightforward system. You earn cash or get a discount on your final balance for every purchase. For example, your cashback card may offer a 2% cash back on every purchase. This means that if you spend $100, you will get a $2 discount. In the short run, it might sound like minor savings, but if you add it all up for a year, it could turn out to be a significant way to save money.

Credit card companies will compete with each other to give the best cashback credit card rates. Also, some purchases might give you a higher percentage than others: you might get higher discounts at certain businesses that have an agreement with the credit card company. These businesses might include grocery stores, gas stations, select streaming services, or wholesale clubs. Cash rewards end up looking super attractive for cardholders.

2. Points

Unlike cashback cards, credit card rewards points add up as you spend. Instead of getting a discount, you accumulate points from each purchase on your rewards card. You might get more points depending on your spending category, and points might be more valuable to spend in one business than another.  To maximize the benefit of these points, you have to do a lot of work.

For example, you might get a point for every dollar you spend, but those points might be worth more at a pharmacy than at a gas station. Also, you need to make sure you make eligible purchases - and not all businesses will accept that credit card’s points. Points might expire with time, and deals between businesses and credit card issuers might change. If today it's better to spend your points at a grocery store, tomorrow they might be worth half of what they used to be in the same store. You have to follow the credit card’s terms to make the most of it. 

3. Miles

Travel rewards are one of the most famous and popular credit card programs. People see it as an opportunity to get discounted plane tickets and hotel upgrades as they do their everyday shopping. They operate quite similarly to points, you might get more miles depending on what you are spending. You can get discounts on flights, a certain hotel chain, travel purchases, or rental cars if you make eligible purchases. If you get enough miles you might even get a free flight or an all-expenses-paid trip. Both points and miles programs have specific spending categories that are rewarded in different ways.

Who pays for the benefits credit cards give away?

According to these stats, 7 out of 10 Americans own a credit card, and most of them have many cards. Some people will spend a great amount of time juggling with their cards, trying to outbrain the system and using them in different ways to hunt for the rewards on everyday purchases. But, what's the catch?

Credit card issuers have three sources of revenue:

1. Interest

2. Annual Fee

3. Interchange

You've probably heard of the first two because Federal law requires card issuers to disclose these items to consumers. But the third one might be new to you. The reason is that interchange fees are virtually invisible to consumers. Merchants have to pay between 3% and 4% of their earnings every time a customer swipes a card: these are called interchange fees, also known as swipe fees. Merchants don’t just pay these fees - they pass them on to the consumer in the form of higher prices.

The thing is, merchants don't set a different price for each payment method. They charge the same amount of money from those customers that pay with credit, a debit card, direct deposit, or cash. As a result, all consumers pay more.

You might think a credit card issuer's biggest source of revenue is the interest they charge from unpaid balances, but that’s incorrect. According to a study by the economist Aaron Klein, credit card issuers' first source of income is interchange fees. American Express, for example, booked $24 billion in swipe fees in 2018.

The credit card company’s rewards program passes just a fraction of these higher prices back to you.  

Cash users pay for luxury card users' benefits

On a bigger economic scale, the wealthier part of the population benefits from credit card rewards while the majority of the middle and lower-income people end up paying higher prices for everyday items.

Scott Schuh, Oz Shy, and Joanna Stavins from the Federal Reserve Bank of Boston wrote a paper in which they calculated how much extra money the lower-income families pay versus the capital saved by the wealthier population: “Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or "cash") users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. On average, each cash-using household pays $149 to card-using households and each card-using household receives $1,133 from cash users every year.”

Their conclusion after conducting this study is that reducing merchant fees and card rewards would have a great positive impact on the consumer's welfare.

6 dangers of credit card points

1. Overspending

Points and miles rewards programs are literally designed to make you spend more. The more you spend, the more you get. And that might be fine if you’re not on a tight budget. But if you are, these types of reward programs might be making you spend more than you should. You’ll get that email telling you that for the next three days, you get double points, and though you weren't sure about buying those shoes, you’ll buy them.

Some say that free stuff is the most expensive stuff. If you go over your budget or don't pay your credit card bill on time, you might have to pay interest that will end up being more than the travel rewards you were expecting. You have to be on top of your billing cycle every time.

This article by Drazen Prelec from MIT Management Sloan School explains how people tend to spend more when using credit cards instead of cash. This is a psychological effect due to many reasons: they reduce the pain of payment while reinforcing what scientists call “the reward network” of the brain. Shopping releases dopamine. And since you won't have to pay until months from now, the pain of paying is reduced. Credit card points act as a pain mitigator as well: I am not only shopping for something I want but I am also getting rewarded for spending money. It's pure positive reinforcement.

2. Reward expiration dates

To make a real saving, you have to use what you’ve earned on your card. Many times points will expire before you can get enough to redeem them. If you’re not going to use your reward right away, it might not be worth swiping your card away to get it. Rewards can also change with time. Once you manage to get enough points for the item you want, nothing guarantees the item will be available.

3. Fine print

But other factors could make you lose your points. The fine print usually explains many ways in which points could expire. Did you know you could lose all your rewards by missing one payment? Rules change from card to card, but customers could lose all or a percentage of their points for lack of payment, card inactivity, or, as we've mentioned before, restructuring of the rewards program.

4. Caps on rewards credit cards

Depending on the card you get, it may come with a cap on rewards. For example, your 2% cashback might be limited to $1,000 per quarter. If you have bigger spending habits, you could be missing out on a lot of savings you were expecting. This might mean the card is not as helpful as you thought it would be.

5. Annual fees

As we discussed in a previous section, credit card companies make money out of annual fees. Usually, these fees aren't obvious upfront. They will first talk about all the benefits and rewards. You must be very careful if and when signing these contracts and understand every charge completely. If you don’t understand how they function, those annual fees will outnumber your credit card rewards.

For example, your card offers travel miles and has a $70 annual fee. If you spend $7,000 yearly and pay it off each month, it will take about three years to get a free ticket. By then, you will have spent $210 in annual fees, which means, you could’ve already paid for your flight instead of the fees.

6. Interest Rate Bait

A sales strategy some companies have is to give you a low introductory interest flat-rate card. You bite and sign up for the credit card. All of a sudden, your interest rate jumps up to 15% or more. And even if you are completely sure you will be able to pay for your card each month, sometimes life happens and you miss a payment. And whatever you are charged for missing a payment might double or triple what you thought you were saving with your card’s “benefits”. You can get into a big mess by making just one little mistake.

If you think a credit card is too good to be true, it probably is. Don’t fall for the bait!

Here's what to do instead:

The bottom line is that having a rewards credit card keeps you in defense mode. Whether you are trying to outsmart the points system or if you're using auto-pay and calendars to never miss a payment, it always feels like something might go terribly wrong. Credit card usage drives up costs for everyone.

In the end, rewards do teach us something about our spending habits and shopping desires: we like to get an extra treat. And we don’t need a credit card company to choose it for us. By using a controlled budget and a smart saving strategy, you can create a savings fund in your bank account, crafted to fit your own personal reward.

For example, every time you buy groceries, put 2% into your “Paris Dream Trip” account. Out of every dollar you spend, put a penny aside for those sneakers you’ve been wanting for months. You can get creative and find ways to divide your budget to reward yourself. All of this, while avoiding interest, annual fees, and sweating over an expiration date for your points.

If you really want to undermine the points economy, you have to get rid of it. The U.S. has the highest credit card fees in the world which enable the exploitative points system. 

The EU capped credit card fees and mandated the availability of alternative forms of payment. As a result, Europeans have more options to pay and European businesses pay less to process payments. While it’s unlikely that America will take the same regulatory path, we have the opportunity to make choices that enable this same result.

If merchants de-prioritize credit cards and if enough consumers swear off the high-fee credit cards, prices will go down, competition will increase, and everyone benefits.

Link Money is offering a path to that future through open banking with Pay by Bank. Merchants can integrate with Link Money to pay less in processing fees and give their consumers the option to pay by bank. You might not get to trick yourself into thinking you got a free flight, but everything could be a little bit cheaper for everyone. And maybe have a little less credit card debt, too.