Credit card businesses make money, but they often offer incentives that include prizes such as cash back on credit card transactions. Many people are bombarded with online offers and mailers offering fantastic benefits, such as zero to low introductory interest rates, one-time bonus rewards offers, and cash back deals when they use their credit cards.
Nowadays, it is not uncommon for banks to provide what seem to be quite significant cash back incentives to their cardholders long after the promotional bonus period has expired. Chase, for example, gives up to 5% cash back on its Chase Freedom Rewards Card, as does Discover. So, how can these businesses give such obviously advantageous bargains to customers while still making a profit?
- While most cash rewards programs give a nice 5% cash back incentive, there may be an annual ceiling or maximum level you may attain.
- When retailers accept credit card payments, they must pay a percentage of the transaction value to the credit card provider.
- Credit card firms also profit by charging high interest rates on debt carried over from month to month and by collecting late fees for payments missed or paid after the specified due date.
Cash Rewards Programs: The Fine Print
First and foremost, it is critical to read the tiny print. While most cash rewards programs give a nice 5% cash back incentive, there may be an annual ceiling or maximum level you may attain. Other cards only provide cash back on certain transactions, such as those made at restaurants or petrol stations.
Discover’s cash back card is one of several that offers a 5% cash back incentive on purchases. However, as of 2018, the cardholder agreement indicates that this promotion is limited to specified categories assigned to various periods of the year. It also has a buying restriction of $1,500 every quarter. The disclaimer also warns that using an NFC-enabled credit card or a virtual wallet such as Google Wallet may not count toward the program.
Similarly, the Chase Freedom card includes spending limits and limitations. Cardholders may get 5% cash back on purchases in select areas. Chase, like Discover, has a quarterly spending restriction of $1,500. Any further purchases made throughout the quarter that exceed the limit receive 1%.
With a credit card program that offers a $1,500 cash back cap per year at 5%, any expenditure beyond $30,000 would not contribute to the accumulation of any further cash back benefits.
Because most customers do not read the tiny print, they may establish a credit card account believing that cash back rewards schemes are much more generous and widespread than they are.
It’s Not Free Cash
When retailers accept credit card payments, they must pay a percentage of the transaction value to the credit card provider. If the cardholder is enrolled in a cash back rewards program, the credit card company simply splits a portion of the merchant costs with the customer. The idea is to encourage individuals to use credit cards instead of cash or debit cards, which do not earn them incentives. The credit card firm might receive more merchant fees the more a customer uses a credit card.
Credit card firms also profit by charging high interest rates on balances that roll over from month to month and by collecting late fees for payments missed or paid after the specified due date. The more credit cards individuals use, the more probable it is that they will miss a payment or carry a balance for which they would be charged penalties and interest.
According to the Federal Reserve, the average credit card interest rate in the first quarter of 2020 is 16.61%. In addition, the Federal Reserve reported about $1.07 trillion in outstanding revolving credit by March 2020. According to the most recent Federal Reserve Survey of Consumer Finances, around 45% of credit cards carry a load from month to month. 1
Credit cards with the most generous-sounding rewards programs often have the highest fees and interest rates when compared to a comparable card with a smaller rewards program, or no rewards program at all.
The Bottom Line
Cash back benefits seem appealing, and they might help some customers save money on credit card transactions. However, if the limits and conditions, including any limitations on how much cash back credit card users may receive every year, are spelt out in the tiny print, these programs do not seem to be as lucrative as they may look on the surface.
Because these programs incentivize customers to use their credit cards instead of cash or debit cards, they boost merchant fees for the credit card company and may encourage some consumers to incur further debt, presenting the credit card company with yet another stream of income.
According to the Federal Reserve Bank of Boston, the average transaction value for a non-cash transaction is approximately four times that of a cash transaction, significantly increasing merchant fee income. People prefer to spend more on cash back credit cards than non-rewards cards because they provide the subtle psychological incentive of earning money while spending. As a result, rather than depleting corporate earnings, cash back incentive programs significantly boost credit card issuers’ bottom lines. 2
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