You’ve definitely seen rewards credit cards, that are seemingly too good to be true – two free flights, $200 cash, you name it. But are these rewards credit cards always a good idea? There are some cases where free money is hardly free.
Why do rewards cards exist?
There’s a simple reason for the existence of rewards cards: They make you spend more money. When you don’t pay off that debt, the credit card company earns interest. And for comparison, if you earn 1% rewards and your rewards credit card has 15% interest, paying the minimum balance for just one month will mean you lose more in interest than you earn in rewards.
The key to beating the system is understanding incentives. Card companies offer incentives for you to spend, hoping that you won’t be able to pay it off in time. The other reason they want you to spend is that when you pay by card, the merchant has to pay a fee, and the bank takes a cut. The takeaway for you is that you can have a mutually beneficial relationship with the bank, in which they get fees from the merchants and you get rewards from them. The big thing is not to carry a balance – that’ll end up costing you.
When should you get a rewards card?
You pay off your bills every month. If you don’t carry a balance, you can enjoy the benefits of rewards credit cards.
You make a lot of business expenses. Not only does it help separate your business and personal expenses, but you can earn rewards from corporate spending. Whether you get the rewards or your company does is up to the person who set up the account.
When should you avoid rewards credit cards?
You carry a balance. Trust us – no matter how attractive the rewards may seem, you’ll probably end up spending more money on interest payments than you earn in rewards. If your card has a 12% APR, you’re charged 1% of your outstanding balance every month; even without compounding interest, that’ll nix your rewards on a basic 1% rewards card.
Rules of thumb:
Don’t just get a rewards credit card because you travel abroad. There are some low interest cards with no foreign transaction fee – take a look at offers from Discover or Capital One, as all of their cards have no F/X fee.
Beware of debt. Debt for frivolous reasons – I want this shiny new thing – can form a dangerous habit. However, there are some times when debt is an investment. For example, student loan debt makes sense if your degree will let you earn more than you pay out.
Best of luck finding the best credit card for you! If you have questions, feel free to leave a comment below.