January 04, 2021 | money-management
How Do Cash Back Credit Cards Work?
If you’re on the hunt for a new credit card, you might be a little overwhelmed with all the options, especially when it comes to rewards credit cards. As the name suggests, rewards credit cards offer some rewards on your credit card purchases. Some companies offer airline miles when you spend, while others give you points that can be redeemed for merchandise.
However, one of the most popular types of rewards that credit card companies offer is cash back on your purchases. In this article, we’ll break down everything you need to know, including how cash back credit cards work and the pros and cons of this financial product.
How Do Cash Back Credit Cards Work?
A cash back credit card is a type of rewards credit card that offers money back on what you spend. How they work is pretty simple— you’ll earn a cash credit on a percentage of qualified purchases. Redeeming your cash back credit is also pretty easy. Credit card companies will typically give you the option to put the money towards your credit card bill, have a check sent to you, or deposit the money directly into your bank account.
What differs across cash back credit cards is what counts as a qualified purchase and what percentage you’ll get back. Rewards may look something like:
- 5% cash back on the first $2,000 of combined quarterly purchases in your choice of two spending categories
- 2% unlimited cash back on one category of spending that the credit card company rotates quarterly, like grocery stores or gas stations
- 3% cash back on a category that you select monthly
Again, these are just examples of what rewards may look like. Yours may end up looking a little different depending on your particular card.
Pros of Cash Back Credit Cards
So how does a cash back credit card stack up against other types of credit cards? Here are some of the advantages and disadvantages you’ll find with this rewards card compared to others.
The biggest advantage of cash back credit cards is a no brainer— the cash back! Everyone likes having a little extra money back in their pocket, especially when you buy things that you would purchase anyway.
You might get some sweet sign-up bonuses
Many credit card companies offer great sign-up bonuses just for opening a credit card. This can come in many forms, like higher introductory reward rates. Other cards may offer deals like $150 if you spend $500 with the card in the first three months.
They can help you improve your credit score
This isn’t unique to cash back credit cards, but they can help you improve your credit score if utilized correctly. Getting a credit card has some credit-score boosting advantages like increasing the types of credit that you have. Managing different credit types looks good to creditors, so if you only have installment credit (like an auto or home loan), adding a revolving line of credit to the mix can look good.
Additionally, credit cards also allow you to lower your credit utilization rate— as long as you’re using it properly, of course. But don’t forget applying for a new credit card will be an inquiry on your credit, so don’t “chase” points unless you have a solid financial reason to do so.
Cons of Cash Back Credit Cards
As with any credit card, there are downsides to a rewards card. Here are a few potential drawbacks to consider before making up your mind about a new card.
You might face higher APR rates
Your credit card’s interest rate depends on several factors, including your own credit score, but in general, rewards credit cards have a higher APR.
Of course, this isn’t an issue if you diligently pay off your balance each month. But if you think there’ll be times when you want to pay the minimum balance, a high-interest rate can cause your balance to snowball quickly.
There may be foreign transaction fees
Some other rewards cards specialize in travel. That means that the rewards can be redeemed for airline and hotel accommodations and the card has additional benefits to frequent international travelers, like waived foreign transaction fees. Cash back credit cards, on the other hand, typically don’t waive these types of fees.
You might be tempted to spend more
Some people get roped into the allure of racking up rewards and end up spending more than they should. As with any credit card, it’s important to remember that you still have to pay the money back— and if you don’t pay it back quickly, the interest can add up.
You’ve got to spend to earn rewards, but you don’t want to spend so much that you bury yourself in credit card debt. You can easily avoid this disadvantage by using your credit card responsibly.
What to Look for When Selecting a Cash Back Credit Card
Like most financial products, not all cash back credit cards are created equal. When selecting a card, there are a few factors to consider.
- Rewards percentages and categories. It’s important to know how much you’ll get back and for what. Some cards set the qualified categories for you, while others let you choose.
- Rewards limits or caps. Be sure to read the fine print. Some credit cards put limits on the amount of cashback you can receive. Others have unlimited cash back on qualifying purchases.
- How your cash back credit is redeemed. Check to see how you’ll get your cash back. Some cards will let you use your rewards via a direct deposit, check, or statement credit. Others will send you a gift card to a popular retailer like Amazon. Most credit card rewards must accumulate a minimum amount of points before any points can be redeemed or cashed.
- Annual fees. Some cash back credit cards have annual fees. If you don’t use the card often, the fees may outweigh the benefits.
- The interest rate. This is something you’ll want to look at any time you take out a credit card or loan.
Knowing these three things will help you pick the right card for you.
Cash back credit cards are an easy way to get money back in your pocket on everyday purchases. They’re easy to use and can have many benefits on top of the named perks of the card. But of course, like any credit card, they can help your financial standing only if you use it responsibly.
Earn Cash Back on Your Purchases
Earn cash back on credit card purchases with a Visa® Max Cash Preferred Card from Amplify Credit Union.