Like most people, I like the sound of getting 2 cents back on every dollar I spend on my credit card. There’s nothing I wouldn’t do for that amazing rewards rate — except pay 2 cents per dollar (or more) to get that cash back.
You might ask, “Who would?” But it can happen more easily than you think. On many cards, all you need to do to negate your rewards earnings is carry a balance from one month to the next. And about 42.5% of credit card accounts revolve debt regularly, according to the most recent data from the American Bankers Association. If you’re carrying a balance on a rewards credit card, there’s a good chance your reward “savings” are just a mirage.
Why we love rewards (even when they cost us)
Rewards cards, which pay out in points, miles and cash back, are the cool kids of the credit card world. About 83% of cardholders reported having a card with a rewards program, according to a separate ABA survey last year. If you pay your balance in full each month without fail, then your rewards really do go right into your pocket. That’s because you never get charged interest if you always pay in full.
But if you carry a balance, you’ll likely pay a high ongoing interest rate — an annual percentage rate of 19.23% on average, according to internal NerdWallet data — wiping out any benefit you might gain from those rewards.
It’s easy to overlook this. Rewards card advertisements emphasize upsides, not downsides, and rewards are easier to understand than interest rates. And even when you get all the facts and figures down, you might be swayed more by rewards than costs because of cognitive biases.
Where small amounts of money are concerned, gains tend to loom larger than losses, according to a paper published in the journal Psychological Science in 2007. In other words, you might be over the moon to find $5 on the sidewalk. But if you lost $5, you might just shrug and move on with life. In a similar way, you might get stoked about the prospect of earning 2 cents per dollar spent, but feel indifferent about an interest rate of 24% (which comes out to 2% a month).
You might not realize you’re getting a raw deal until the interest charges start piling up — and by then, your debt will already be a lot more expensive.
The math doesn’t work out
Rewards are a one-time benefit; interest charges are ongoing costs that increase daily. Even when your credit card’s reward rate is higher than your monthly interest rate, those interest charges can cancel out your rewards if you take a few months to pay down your debt.
Let’s assume you’re earning one of the highest flat rewards rates possible, 2%, and paying 19.23% APR (1.6% interest per month), the average APR on rewards credit cards in NerdWallet’s database. Say you have $10,000 in debt, which you pay off over two months.
If you make equal payments and didn’t add any new purchases, you’ll owe about $241 in interest after the second month. In effect, you’re paying 2.41 cents per dollar spent to get a 2-cent-per-dollar return. And the longer you take to pay it down, the more you’ll accrue in interest charges.
In contrast, you’d owe nothing in interest if you used a card with an active 0% introductory purchase APR. Even if it earned lesser rewards — or no rewards — it would still be a better choice for minimizing your expenses in the short term. If you’re carrying debt over multiple years, a credit card with an ongoing APR under 10% could be your best bet.
A better choice
At best, carrying a balance on a high-interest rewards credit card is a nothingburger. Worst-case scenario, it’s a debt trap. If you’re carrying a balance, you’d be better off finding ways to minimize costs, instead of earning more rewards. Here’s how:
Avoid fees. If you’re trying to get out of debt, getting a card without an annual fee is a smart place to start. A card that doesn’t charge late fees might help you out, too.
Think about perks later. Once you’ve winnowed your choices down to two or three low-interest offers, revisit those rewards rates. If you find a card that offers both a low interest rate and rewards, consider applying.
Low interest rates aren’t as dazzling as high rewards rates. But for those carrying balances, they’re a better deal.