Who Pays for Credit Card Rewards: You’ve probably gotten an offer for a credit card at some point, whether it was in your email or in the mail. “Register, and you’ll get 80,000 bonus points!” “Get $300 cash back when you spend at least the minimum amount.”
The deals sound appealing. Who doesn’t want free money or points that let them travel the world?
But what are rewards on a credit card, really? It’s a simple idea. When you use your credit card to buy something, the company that gave you the card will give you points, miles, or cash back. Credit card rewards have a set value that can change depending on the card issuer and the offers.
But if ads make it seem like they are just “free” money, why do credit card companies even have them? In short, companies that give rewards pay for them. You need to know how credit card issuers make money to understand why this set-up is good for these companies.
Here’s what you need to know about the complex network of industries that leads to the rewards you get from your credit card.
Do I have to pay for the rewards I get?
Sometimes, but in a roundabout way.
Dan Stous, a certified financial planner (CFP) and lead wealth advisor at Flagstone Financial Management, says, “At the very least, you pay for some of the rewards you earn by paying more for the goods and services you buy.” “Credit card companies charge merchants a fee to accept cards as a form of payment, and merchants pass that cost on to you in the form of higher prices.”
Stous says, “If you do it right, you can make a lot more than you pay for.” “Merchants charge everyone the same price, so whether you use a card that gives you points or pay cash, you’ll pay more.”
How do people who sell credit cards make money?
Credit card companies can make money in three ways:
Interest on credit cards may be the most well-known way for card issuers to make money. Before you apply for a card, the law says that the APR range must be shown. Your exact APR will be in the Schumer Box, which is part of the information packet that comes with a new credit card.
“The credit card rewards model is still very much alive and well for people who pay their bills in full,” says Ted Rossman, a senior industry analyst at Bankrate. “I always tell people to pay their bills in full, because math only works out in your favour if you don’t pay interest.”
Interest payments can be avoided because they are added to the amount still owed. If you pay off your credit card balance in full and on time every month, you shouldn’t have to pay interest.
“Even carrying a balance once in a while can be worth more than any rewards you earn,” says Rossman. “If you owe money on your credit cards, don’t worry about rewards. Get the lowest interest rate you can or just use cash or a debit card.”
There are many different kinds of fees for credit cards, such as annual fees, late fees, cash advance fees, and balance transfer fees. Unlike interest, you can’t always avoid fees that come with credit cards.
People with little or no credit history or bad credit may only be able to get subprime cards with fees. On the other hand, many of the best rewards cards also have high annual fees, which are usually made up for by the rewards and perks that come with the card.
Interchange fees may be the ones that the average person with a credit card knows the least about. But if you own a business or sell goods of any kind, you’ll know all about interchange fees.
When a credit card is used to pay for a good or service, the merchant will be charged an interchange fee that is between 1% and 3% of the total charge. The word “exchange” refers to the complicated payment system that makes these fees possible. The fees that come with it depend on how many transactions the merchant handles.
Brian Riley, who is in charge of Mercator Advisory Group’s credit research group, says that even though interchange fees may seem high, lowering them could hurt more than help. “In many studies of the Australian market, where the Reserve Bank controlled interchange fees, few or no consumers benefited from the required price cuts,” Riley says.
Riley isn’t the only one who thinks this way. Rossman says that the biggest threat to credit card rewards would be if interchange fees were capped. In Europe, both credit and debit cards have had this happen, but in the U.S., only debit cards have.
To understand why putting a cap on interchange fees could be bad for consumers, you need to know how some laws affect the credit card market. In particular, think about the 2010 Durbin Amendment that was added to the Dodd-Frank Act. According to an economic brief released by the Federal Reserve Bank of Richmond soon after the Durbin Amendment was passed, it “had limited and uneven effects on lowering merchants’ costs of accepting debit cards, and for some merchants [it] raised costs.”
3 ways to avoid extra charges
1. Know what you’re getting yourself into.
Make sure you know the annual fee and interest rate for your next credit card before you choose it. One of the most avoidable costs of a credit card is a high annual fee, and many great rewards cards have no annual fee.
It’s also important to make sure that the card’s rewards will cover any fees. “Some airline cards come with perks like free checked bags, memberships to ride-sharing VIP programmes, or access to airport lounges,” says Stous. “These perks can be very valuable.” “But if you only use the card a few times a year, don’t earn many points, don’t use any of the perks, and pay a high annual fee, you might be losing money.”
2. Always pay off your whole balance.
When interest is added, a credit card can quickly go from being a useful tool to a financial burden. Interest is how credit card companies make money, and some of the most common fees that come with credit cards are for late payments. When picking a credit card, you should only spend what you can realistically pay off in a month. If you spend more than that, you could lose money instead of earning rewards.
3. Don’t get cash advances.
Cash advances may seem like a good way to get money quickly, but they always come with a high price. In addition to high interest rates, credit card companies can add 3–5% to the cost of the advance, which can add up quickly.
Cash advances are different from other charges on your credit card in that there is no grace period before interest is added. As a general rule, you should avoid cash advances unless you have to.
Credit card companies can give cardholders good rewards cards because they get money from other customers and merchants in the form of interest and fees. So, if you want to get the most out of your rewards credit card, you should avoid carrying interest, which will almost always be more than the rewards you get.
Also, be aware of any fees that come with your credit card, like an annual fee, balance transfer fee, foreign transaction fee, or cash advance fee, to make sure that the benefits of your card outweigh the costs. If you pay an annual fee, you often get access to good rewards. However, if you pay other fees on your credit card often, you may lose the rewards you’ve earned (and end up paying for someone else’s).