Who Pays for Credit Card Rewards: You have probably at some point received a credit card offer, whether it arrives in your mailbox or email inbox. Get 80,000 bonus points when you sign up! When you spend the required amount, you will receive $300 in cash back.
The offers seem tempting. Who wouldn’t want free cash or points that would let them take a worldwide vacation?
But what do credit card rewards actually consist of? Simple is the concept. Using your credit card to make purchases entitles you to points, miles, or cash back from the card’s issuer. The set value of credit card rewards can change depending on the offer and the credit card company.
But if they are merely “free” money, as some advertisements might suggest, why do credit card issuers even have them? In essence, credit card providers fund rewards. You must be aware of how credit card issuers generate revenue in order to comprehend how this arrangement benefits those businesses.
Here is the information you need to know about the intricate web of industries that results in the rewards you receive from your credit card.
Am I paying for the rewards I earn?
occasionally, but not always.
According to Dan Stous, certified financial planner (CFP) and lead wealth advisor at Flagstone Financial Management, “At a minimum, you pay for some of the rewards you earn through increased prices on the goods and services you buy.” “Credit card companies charge merchants a fee to accept cards as a form of payment, and merchants pass along this cost to you in the form of higher prices.”
If you do it correctly, “you can earn a lot more than you pay for,” says Stous. “Merchants charge everyone the same price, so whether you pay with a card that earns points or with cash, you’ll pay higher prices.”
How do card issuers get paid?
Credit card companies can generate revenue in three different ways:
Interest
The most well-known source of income for issuers may be interest on credit cards. Before applying for a card, you are legally required to see the APR range. Your precise APR will be disclosed in the Schumer Box, which is a packet of information that comes with a new credit card.
According to Ted Rossman, senior industry analyst at Bankrate, “the credit card rewards model is still very much alive and well for consumers who use credit cards and pay their bills in full.” Because the math only works out in your favour if you pay your bills in full and avoid interest, I emphasise paying them off completely.
Since interest is charged on unpaid balances, interest payments are avoidable. You shouldn’t be assessed interest if you pay off the balance of your credit card each month in full and on time.
According to Rossman, “even occasionally carrying a balance can outweigh the value of any rewards you earn.” “Pay attention to your debt rather than rewards if you have credit card debt. Choose the option with the lowest interest rate, or just stick to cash or debit.
Fees
There are many different types of credit card fees, such as annual fees, late fees, cash advance fees, and balance transfer fees. In contrast to interest, credit card fees are not always avoidable.
Subprime cards with fees might be the only choice for those who have a spotty credit history or poor credit. The high annual fees associated with many of the best rewards cards, however, are typically offset by the benefits and rewards they offer.
Interchange
The least well-known item on this list for the typical credit card user is probably interchange fees. Interchange fees, on the other hand, will be all too familiar if you’re a business owner or merchant of any kind.
The merchant is required to pay an interchange fee, which can range from 1 to 3 percent of the total cost, each time a credit card is used to make a purchase. The intricate payment network that enables these charges is referred to as the “interchange” in its name. Additionally, the fees related to it change depending on how many transactions the merchant processes.
Interchange fees might seem high, but lowering them might have more negative effects than positive ones, according to Brian Riley, director of the credit research group at Mercator Advisory Group. Few, if any, consumers benefited from the required reductions, according to numerous studies on the Australian market where the Reserve Bank implemented interchange price controls, claims Riley.
It’s not just Riley who thinks this way. The biggest threat to credit card rewards, according to Rossman, would be a cap on interchange fees, which has already been implemented in Europe for both debit and credit cards, but only for debit cards in the United States.
Understanding some of the legislative forces that affect the credit card market is necessary to comprehend why capping interchange fees might harm consumers. Take into consideration, in particular, the Durbin Amendment, which was incorporated into the Dodd-Frank Act in 2010. The Federal Reserve Bank of Richmond stated in an economic brief that the Durbin Amendment “had limited and unequal impact on reducing merchants’ costs of accepting debit cards, and… for some merchants [raised] costs.”
3 recommendations to prevent additional charges
1. Be informed before enrolling.
Make sure you are aware of the annual fee and interest rate associated with the card before choosing your next credit card. One of the credit card costs that can be avoided the most is high annual fees, and many fantastic rewards cards have no annual fee.
Additionally, it’s crucial to confirm that any card costs will be offset by the rewards. According to Stous, “some airline cards offer benefits like free checked baggage, memberships to ride-sharing VIP programmes, or access to airport lounges, and those benefits can be really valuable.” However, if you pay a high annual fee, use the card infrequently, don’t earn many points, and don’t take advantage of any perks, you might actually be losing money.
2. Consistently settle your account in full
A credit card can quickly transform from a helpful tool to a financial burden if there is added interest. Interest is a source of revenue for credit card companies, and late payments are a common cause of some of the most expensive fees connected to credit cards. When selecting a credit card, it’s crucial to only spend what you can afford to pay off in full each month; otherwise, you run the risk of losing money rather than accruing rewards.
3. Steer clear of cash advances
Although a cash advance may seem like a great way to get money quickly, they always come at a high cost. Credit card issuers may additionally impose fees ranging from 3 to 5 percent on the cost of the advance, which quickly adds up on top of the high interest rates.
There is no grace period prior to interest on a cash advance, unlike regular charges on your credit card. Always try to avoid cash advances unless they are absolutely necessary.
The final word
Because of the interest and fees they receive from other customers and merchants, credit card issuers can offer rewarding rewards credit cards to cardholders. Since carrying interest will almost certainly outweigh the yield of your rewards, avoiding it is the key to getting the most out of your rewards credit card.
In order to ensure that the advantages of your card outweigh the costs, you should also be aware of the fees attached to your credit card, including any annual, balance transfer, foreign transaction, or cash advance fees. Even though paying an annual fee can often be justified by the access to generous rewards, regularly paying other credit card fees will probably negate any rewards you have already accrued (effectively making you pay for someone else’s rewards).
