Credit card companies are in the business of making money, yet they often advertise incentives that feature rewards such as cash back on credit card purchases. Many consumers are inundated with online offers and mailers, promising great incentives, from zero to low introductory interest rates to signup rewards offers, to cash back deals whenever they use their cards.
Nowadays, it isn't unusual to see banks offer what seem to be very generous cash back incentives to their cardholders, even after the introductory bonus period is over. For example, Chase offers up to 5% cash back on its Chase Freedom Rewards Card, as does the Discover Card. So how can these companies offer such seemingly lucrative deals for consumers and still make a profit? (For more, see: Credit Card Tutorial.)
Cash Rewards Programs: The Fine Print
First, it is important to read the fine print. Most cash rewards programs have an annual maximum limit, so while they may offer a generous 5% cash back reward, there may be an annual cap or maximum limit you can reach. Other cards only offer cash back for certain categories of purchases, such as at restaurants or gas stations.
Discover's cash back card is one of those that boasts a 5% reward on purchases. But, as of 2018, the cardholder agreement states that this offer only extends to specific categories allotted to different quarters of the year. And it comes with a limit of $1,500 in purchases per quarter. The 5% reward would qualify for gas stations and wholesale clubs between January and March; grocery stores between April and June; restaurants between July and September; and Amazon and wholesale clubs between October and December. Any additional spending in those periods, and anything spent on these categories above the $1,500 cap would only net a 1% cash reward. The disclosure also states that using a credit card with NFC technology or from a virtual wallet such as Google Wallet may not count toward the program. (See also: Credit Card Rewards: Cash Back Vs. Airline Miles.)
Similarly, the Chase Freedom card also has spending restrictions and caps. Between January and March, cardholders can earn 5% cash back rewards on gas station purchases, internet, cable and phone services. Grocery stores (excluding purchases from Walmart and Target) qualify in the next quarter, followed by purchases at gas stations, Lyft and Walgreens in the third quarter. In the final quarter – October through December – cardholders can accumulate 5% cash back on purchases made at select department stores and wholesale clubs. Chase caps the spending limit each quarter at $1,500, just like Discover. Any other purchases during each quarter, and above the limit, earn 1%.
With a credit card program with a $1,500 cash back limit per year at 5%, any spending over $30,000 would not contribute to accumulating any further cash back rewards. (For more, see: Rewards Credit Cards.)
Because most consumers do not take the time to read the fine print, they may open a credit card account under the impression that cash back rewards programs are much more generous and universal than they actually are. (See also: Investing in Credit Card Companies.)
It's Not Free Cash
When merchants accept payment via credit card, they are required to pay a percentage of the transaction amount as a fee to the credit card company. If the cardholder has a participating cash back rewards program, the credit card issuer simply shares some of the merchant fees with the consumer. The goal is to incentivize people to use their credit cards when making payments rather than cash or debit cards, which earns them no rewards. The more a consumer uses a credit card, the more merchant fees the credit card company can earn. (See also: Comparing Credit Card Companies.)
Additionally, credit card companies make money by charging high interest rates on credit and issuing late fees for balances that carry over from month to month. The more consumers use their credit cards, the more likely it becomes that they will miss a payment or carry a balance for which they will owe fees and interest.
According to Creditcards.com, the average credit card interest rate is 17.07% as of Oct. 2018. The Federal Reserve reported almost $1.03 trillion in outstanding revolving credit by April 2018. About 38% of consumers were carrying a balance on their credit cards versus paying the balances off in full each month as of 2018, according to Creditcards.com.
Credit cards that offer the most generous sounding rewards programs also often carry the highest fees and interest rates, compared to a similar card with a lower rewards program, or none at all.
The Bottom Line
Cashback rewards sound enticing, and they can help certain consumers save a bit on credit card purchases. However, once the restrictions and qualifications are spelled out in the fine print, including any limitations on how much cash back credit card users can earn per year, these programs do not appear as generous as they may seem on the surface.
Because these programs are incentives for consumers to use their credit cards in lieu of cash or debit cards, they generate increased merchant fees for the credit card company and may also cause some consumers to increase their debt, providing yet another source of revenue for the credit card company. Rather than draining corporate profits, cash back rewards programs are ingenious marketing tools that actually increase credit card companies' bottom lines. (For more, see: Find the Top Cash Back Credit Cards.)