The concept of getting paid to spend sounds too good to be true, but for many cash back card members, it’s a reality. Cash back can be a rewarding way to get the most value out of your credit card. Understanding how does cash back work for credit cards can help you choose which card is right for you.
About 70% of Americans have at least one credit card, according to CreditCards.com, and credit card companies use rewards programs to keep their customers happy. From getting cash back to airline miles, there are varied reward programs meant to satisfy all types of cardholders.
To put it simply, cash back means you get money back when you use your credit card. Want to know how cashback works on a credit card? And how you can choose the right cash back-card for your lifestyle? Keep scrolling to find out what you need to know about cash back credit cards. If you aren’t sure how credit cards work, you will want to check out this guide.
How Does Cash Back Work On Credit Cards
A 2016 U.S. Consumer Payment Study by Total System Services, Inc. found that 54% of consumers found cash back discounts on purchases to be the most useful feature on a credit card, outranking discounts. So how does cashback work?
When you buy anything with a cash-back credit card, you earn what’s known as a “cash credit” for a percentage of the purchase, which is typically 1% to 2%. Some spending categories may be favored over others such as gas or groceries, which could earn you up to 3% back. It’s like getting a built-in rebate on your purchase.
You can also find cards that have a rotating special spending category, which can change quarterly. This means that the cashback rate is temporarily set at about 5%. From January to March, you might earn 5% on gas and then for April to June it would drop back down to 1%. During April to June, restaurant spending might earn you 5% back and then the cycle continues to the next category.
Because these cards are sought after and have great rewards, you typically need a very good credit score in order to qualify for one that has high cash back percentages and a low-interest rate.
The Types of Cash Back Cards
Cash back cards come in three different types, which are categorized based on how they pass on rewards to their cardholders. Understanding the difference between them with help you understand the question of how does cash back work:
- Flat-rate cash-back cards
- Tiered cash-back cards
- Bonus category cards
We’ll break down these three types of cards so you can understand what the rewards earn and can find which card is right for you.
Category Bonus Cash Back Cards
Category bonus cash back cards offer up to 5% back from spending categories. Some cards that offer this are the Discover it Cash Rewards and Discover More cards, the Chase Freedom and Citi Dividend cards.
The reason the cash back is set at 5% is because it takes work to reach the requirements for it. You need to max out your spending categories and register for the bonus categories every quarter (i.e. every three months). The spending in each category is capped every quarter and purchases not in the bonus category earn only 1% or 2%.
Discover has gone against the grain and published their entire year of bonus categories for the first time to make it easier for consumers to plan their spending:
Chase Freedom released its first quarter 2018 bonus categories back in December:
As a cardholder, you’re responsible for knowing which categories are the bonus categories each quarter and the requirements you need to meet in order to get cash back. This option is good for people who are able to keep track of their spending and can remember which cards earn them the greatest returns throughout the year.
Tiered Rewards Cash Back Cards
Tiered rewards cards give you more cash back in select spending categories, but you have to consider which card to use every time you spend. This means that you might reach for your American Express Blue Cash Preferred Card for grocery shopping in order to earn 6 percent cash back (up to $6,000 in spending per year). You would then take out your Uber Visa Card from Barclays when you dine out to get 4% back.
This could be the right choice for you if your spending is mostly in a certain category that can earn you the most back. The tiered card combined with a flat rate card is usually a good option because after you’ve reached your spending limit on the tiered card, you can use your flat-rate card to get more cash back on all purchases. This is not the best option for people who would rather use any card in their wallets and not think about which one provides the greatest return.
Flat-Rate Cash Back Cards
Flat-rate cash back cards give you a flat percentage rate back on every purchase no matter what it is. There’s also no limit on the amount you can earn.
The Citi Double Cash Card gives you 1% back on every dollar you spend and another 1% back on every dollar you pay off. Other cards like the Wells Fargo Cash Wise Visa® Card offers 1.5% cash back on all purchases.
Although 1% to 2% may not seem like a lot, it adds up over time. If you use your credit cards regularly for daily purchases, then you could start earning $100 to $200 over the course of a year. This option is ideal for people who want the easiest way to earn cash back.
Things to Consider When Choosing a Cash Back Credit Card
You’ll want to read the fine print closely so you understand the details of each card offer. A few questions to answer before signing on the electronic line:
Are the Rewards Worth the Annual Fee?
Paying an annual fee of $75 to $100 can only be offset if you are earning more than that in rewards each year. Keep in mind that with a flat-rate card that offers you 1% back on all purchases you would need to spend $10,000 in order to get $100 back.
Some offers will have a waived annual fee for the first year, but you need to check what the fee is in the years following. You don’t want to be surprised when you discover a $150 charge on your card just for having it.
What Limits Does the Card Have?
A 5% cash back rate will often have limitations such as minimum spending in a certain category. Additional spending will likely go back to the standard rate of 1% or 2%. That means you might not earn as much cash back as you thought you would.
How Much Self-Control Do You Have?
If the temptations to overspend in order to get cash back will be too great for you to make wise financial decisions, then the rewards really aren’t worth it. If seeing that you need to spend $2,000 on dining out in order to get $100 back when you would normally budget for only $1,000, then that $100 really isn’t worth it because you’re losing out on $400 of your income. If you get stuck in perpetual debt, we have a 6 simple step guide to lowering your credit card debt.
Will You Still Want the Card After the Signing Bonuses Are Gone?
Many cards will give you up to $200 for signing up for a cash back card. Read the details closely to know what it will take in order to start earning cash back. It might be purchases up to $2,000 or $3,000. Are you ready to spend that kind of money? If not, then the $100 signing bonus just isn’t worth it.
How to Cash in on Your Cash Back Rewards
Rewards are one of the most powerful incentives for cardholders and ranked the top feature on consumers’ most preferred credit cards, according to Total System Services. Cash rebates are redeemed a few times a year by 30% of the survey respondents. But these benefits aren’t worth anything if you don’t know how to cash in on the rewards.
There are usually a few ways to cash-in on your cash back rewards:
- Apply the rewards to your balance. You can use your cash back to reduce the amount you owe on your credit card bill each month. This is the simplest option.
- Request a gift card. You can have it mailed to you for use on other purchases.
- Have a check mailed to you or request direct deposit into your bank account. Your bank might also incentivize you to do this.
Some cards guarantee that your cash back rewards will never expire while others require for you to redeem them within a certain period of time. You might also be required to make a certain number of transactions per year, which could be as low as one, in order to keep the rewards points. Also, always check what will happen to your unredeemed cash back if you decide to cancel the card.
How Credit Card Companies Make Money on Cash Back Credit Cards
It may seem like credit card companies are losing out by offering cash back rewards, but they actually use merchant fees to fund it. Merchants pay something called an interchange fee every time a cardholder uses a credit card. This means they don’t receive the full amount of what you pay, it’s usually 1% to 2% of the full price that’s deducted.
When you participate in a cash back reward program, then the credit card issuer is returning some of the merchant fees back to you. This incentivizes you to use your card more, which gives the credit card company even more profits in merchant fees.
Rewards and rebates are often funded based on partnerships and deals made between the credit card issuer and the merchant. Movie theatres, for example, may partner with a certain credit card company to provide promotions and discounts.
Earning money when you spend money is like a dream come true. For those of us smart enough to read the fine print on cash back rewards card offers and understand the system well, it can be a great way to shop smart and save some money. Understanding everything you can about how does cash back work for credit cards gives you the power to find the right card for you.