One of the biggest selling points for some of the top credit cards available today are seemingly generous rewards programs. However, a closer look at the pros and cons of these rewards cards reveals that far too often, chasing credit card rewards is not in your best financial interest.
No Free Lunch
First of all, just like retailers that offer products on sale at a discounted price, credit card companies use rewards programs as a marketing tool to lure customers. While the card companies are certainly on the hook for any rewards redemptions they promise, they make up for these expenses in other ways, such as by charging higher interest rates on rewards cards.
In 2015, the APR on cash back cards was about 2.0% higher than on other cards, including nearly 10% higher for gas station cards. Unfortunately, many card holders are unaware that they are paying a higher interest rate for their rewards card.
The Devil’s In The Details
In fact, recent surveys have found that there’s a lot of harmful information that rewards card holders don’t understand about their cards. While benefits and rewards were found to be the single most important factor for customers in choosing a credit card, J.D. Power recently found that only 63% of card users completely understand how to earn and use their rewards. In addition, 43% are unsure about whether or not they have a maximum rewards limit and 30% don’t know if or when their rewards expire.
The best rewards credit cards out there potentially offer about 5% of the amount spent, but if card holders don’t fully take advantage of the offers or understand the terms and conditions of their cards, the actual benefit is much less. And don’t look for the credit card companies to make these details easy to find or understand.
Save Money By Spending Money?
Another way that these rewards cards can cause more harm than good is by enticing customers to over-spend to redeem rewards or qualify for sign-up bonuses. Sign-up bonuses are a common tool that card companies use to draw new customers, but they often come with a minimum spending requirement within the first few months of activation. Many users will either consciously or subconsciously over-spend to obtain these reward bonuses.
Another example of rewards overspending is airline miles redemption. Sure, you may have earned a free flight, but your credit card company is betting that you will do plenty of spending once you reach your full-priced vacation destination.
Not only do these rewards cards often have much higher interest rates than other cards, they often come with large annual fees up to $450. With a fee that high at a 5% return rate, card holders would have to spend about $9,000 per year on the card just to earn enough rewards to cover the cost of the annual fee. If you tack on an interest rate of 15% or higher on that $9,000, it’s easy to see why the cons of these cards can easily outweigh the pros.
The Bottom Line
In certain circumstances, credit card rewards can offer worthwhile benefits, but far too often they are little more than a trap for card customers. Before you consider racking up debt on a high-rate rewards card, assess your spending habits and compare potential savings with a low interest rate personal loan from an online lender, such as Prosper, Lending Club or SoFi.