We often think of credit cards as financial tools that promote dependency on debt, but that is not entirely true because there are some benefits of using them as well. Responsible use of credit cards can actually help in many ways, such as improving your credit score, providing a safety net when on vacations or faced with a medical emergency and providing a convenient alternative to cash. Certain credit cards also help you save money and that’s what this article talks about.
Nowadays, credit cards companies offer a variety of reward programs that are designed to attract new consumers and to encourage them to use credit cards as much as possible. There are three basic types of incentives that credit card companies offer to consumers:
- Monetary incentives in the form of actual cash being deposited into your account. These are called ‘cash back reward programs’ or ‘cash rewards’,
- Reward points that can be used to buy different products,
- Air miles, travel miles or flyer miles that can be used to purchase airplane travel tickets.
Let’s have look at each of these to see how they translate to savings for you.
How cashback credit card rewards help you save money
Cash rewards or cash back rewards have a pretty straightforward mechanism. Typically, a percentage (anything from 0.5% to 6%) of what you spend via the credit card is added back to your account as a reward.
For example, a 6% cashback reward offer means for every dollar you spend, you get $0.06, which translates to a reward of $6 for every $100 purchase. In other words, a cash back credit card offers you a discount on everything you purchase, so in the case of a 6% cashback credit card, the effective price of everything you buy is at a 6% discount, which is money saved.
While the benefit may not seem like much, cashback rewards are a convenient and low-effort way to get money back, which can be added to your savings, used to repay your credit card bill, or spent on something else.
Fortunately, the Internal Revenue Service usually treats these cash backs as discounts on a sale, rather than income, which means you don’t have to pay taxes on this extra inflow of money.
How credit card reward points help you save money
Reward points are essentially brownie points that you get for using the credit card frequently. They do not automatically convert to money, as cashback rewards do and continue to accumulate as you use your credit card to make purchases. The point system depends on the value of the transaction, such as one point per dollar, or two points per dollar and may either be applicable to all kinds of transactions you make through the credit card or only at certain retail outlets that have partnered with the credit card company.
After reaching various thresholds, these credit card reward points can be redeemed in different ways.
- Gift card: you may convert the points into a gift card that is linked to a particular brand. This way, you get to buy things from that brand for free, as long as they fit within the monetary value of the gift card. You could also pass on the gift card to a loved one as a present.
- Redeem the points to buy items directly from the credit card company’s catalogue / online mall. For instance, say you have managed to gather 1,300 points on your credit card, you may be given the option to redeem these points against a handheld blender for 800 points, or a leather wallet for 450 points.
Using these points to get things you were already planning to buy, is a great way to save money.
How credit card air miles rewards help you save money
Similar to the way cashback rewards and reward points work, credit card flyer miles (also known as air miles and travel miles) are handed out in the form of ‘miles awarded per dollar spend through the credit card’. In other words, the more transactions you make using your credit card, the more flyer miles you will be rewarded with as a loyalty benefit. Depending on the credit card, this could be one mile per $1 spent via the credit card, or 2 miles per $3 spent. Some credit cards also hand out thousands of flyer miles as a sign up bonus to attract as many customers as possible.
Once you have spent enough money and gathered enough travel miles, you can use these to get free airplane rides for yourself, a spouse or someone you know, saving you lots of money. Sometimes these reward programs are linked to an airline’s frequent flyer program and that entitles you to additional benefits like priority boarding or free upgrades for your tickets, from economy to business or first class. which is a nice treat for anyone flying these days.
You normally require thousands of credit card travel miles to redeem them in the form of free tickets, sometimes 10,000 and sometimes more, so it does take a while to get the benefit of a free flight. However, some airlines allow you to purchase extra miles if your credit card air miles fall short of the required threshold.
Is it a good idea to use credit cards for rewards? What’s the catch?
Credit card are a great way to earn rewards if you already use credit cards as part of your routine. You get extra benefits, like cash, free gifts/items and airline flights at no extra cost or effort. However, if you sign up for different credit cards only to enjoy their reward programs, understand that there is more to the story, as we discuss below:
1. Your credit card rewards can be revoked if you carry a balance
The benefit gained through credit card rewards is only material if you remember to payback your credit card bill each month, otherwise the interest rate you get charged on your credit card debt will reverse the cash back benefit on your card. For instance, if the cash back rate is 3% but the credit card interest rate is at 7% (which is pretty low as far as credit cards go because most credit card interest rates are in double digits), you stand to lose money at the end of the day if you carry a balance.
2. Obscure terms of credit card reward programs
Sometimes. credit card companies fail to properly explain how reward programs work. On the surface of it, these loyalty programs may sound wonderful but after reading the fine print, the cashback reward or air miles reward offer may not be worth it. For example, a 4% cashback rate may only be applicable once you spend $2,500 on your credit card. Getting to that $2,500 may happen within a month or it could take several months before you are able to enjoy the benefits of the cashback reward.
3. Credit card reward programs are targeted at consumers with good credit scores
Even though almost every credit card company offers reward programs, not everyone is eligible to receive credit cards with the best reward programs. Credit card companies are very selective about who gets approved for, say, the 5% cashback credit card, because they prefer to attract low-risk consumers with high credit scores. Similarly, the best credit card air miles programs are only available to customers with good credit scores.
4. Your credit card rewards may be reversed
Any credit card rewards in your account can be reversed if you reverse the transaction. Suppose you bought a $500 mobile phone and paid through your credit card. A few days later, you receive $25 in your account as a 5% cashback reward. Unfortunately, you notice a glitch in your phone after a week and decide to return it to the retailer. The $500 will eventually return to your credit card account but the 5% cashback of $25 will also be reversed and removed from your account.
5. Credit card reward policies can change anytime
Credit card companies have the liberty to change their reward policy terms and conditions at any time. Be sure to regularly check the details to stay updated. It may so happen that a consumer merrily used their credit card in an attempt to gather travel miles, only to realize later on that the rate at which the miles are offered has reduced. Similarly, in the case of cashback rewards, the consumer may learn the spending threshold that qualifies them for the 6% cashback has been raised further by another $1,000, or that the cashback rate has been reduced to 2%, which makes the cashback reward program less attractive for the credit card user.
6. Credit card reward programs can expire
While air miles that have accumulated in your account usually do not expire, your credit card reward points may become unusable after crossing the expiry date. The solution is to regularly check in and redeem them before time runs out.
If you are trying to maximize your savings, credit card reward programs offer an easy way out. However, these loyalty programs are only worth the rewards if you are a responsible credit card user with a good credit score and you have the ability to stay on top of your credit card payments. Credit card rewards are certainly not worth it if you tend to carry a balance on your credit card because the interest costs will offset any benefit you stand to gain from the reward program and you may even have your reward points and travel miles revoked.