Key takeaways
- Credit card rewards are paid for by issuers, which pass the bill along to consumers who are charged fees and interest for using their cards.
- The merchant middlemen also indirectly pay for credit card rewards by paying interchange fees, typically 1.5 to 3.5 percent of each purchase that a consumer charges to their card.
- The best way to maximize your credit card rewards is to keep from paying fees and interest on your card altogether. This way, you’re not spending all your cash back or canceling out your accumulated points value on charges you could have avoided.
Whether it shows up in your inbox or mailbox, you’ve probably received a credit card offer at some point. These offers often have headlines like, “Sign up and get 80,000 bonus points!” or “Earn $300 cash back when you meet the minimum spend requirement.”
Of course, they sound enticing: Who doesn’t want free money or points that will allow them to meet their financial goals or travel the world?
But what are credit card rewards in reality? The idea is simple. You pay for items using your credit card, and in turn, the card issuer rewards you with points, miles or cash back based on the amount and category of your purchase. Credit card rewards have a set value that can vary based on offers and the credit card issuer.
But nothing in life is “free,” right? Technically, credit card companies pay for rewards, but that doesn’t mean those costs aren’t passed on to you, the cardholder. Here’s a look at how the rates and fees you pay as a cardholder, as well as those merchants, pay for the ability to accept credit cards as payment and figure into the real cost of credit card rewards.
Am I paying for the rewards I earn?
Sometimes, but indirectly.
“At a minimum, you pay for some of the rewards you earn through increased prices on the goods and services you buy,” says Dan Stous, certified financial planner (CFP) and lead wealth advisor at Flagstone Financial Management. “Credit card companies charge merchants a fee to accept cards as a payment option, and merchants pass through that cost to you in the form of increased prices.
“You can earn a lot more than you pay for if you do it right,” says Stous. “Merchants charge everyone the same price, so you’d pay higher prices regardless of whether you use a card that offers points or you paid in cash.”
You’d also be paying for those rewards in spades if you hold a balance on your credit cards. Carrying a balance means you’re paying interest on your purchase, which usually compounds daily and eats away at any rewards you’ve earned.
How do credit card issuers make money?
Credit card companies make money through three types of fees:
1. Interest
Credit card interest may be the best-known revenue stream for issuers. Issuers are legally required to prominently disclose the annual percentage rate (APR) range of a card for potential applicants. You’ll find that information in the card’s Schumer Box along with more of the card’s most important charges and fees.
For credit card users who pay their bills in full, the credit card rewards model is still very much alive and well. I stress paying bills in full because the math only works out in your favor if you pay in full and avoid interest.
— Ted Rossman, Bankrate Senior Credit Card Analyst
Interest payments on purchases are usually avoidable, as they are applied to outstanding balances. If you pay off your credit card purchases in full and on time each month, you shouldn’t be charged interest on your balance.
“Even occasionally carrying a balance can outweigh the value of any rewards you earn,” says Rossman. “If you have credit card debt, focus on that rather than rewards. Get the lowest interest rate you can or just stick to cash or debit.”
Keep in mind: Paying off your purchases in full each cycle will usually allow you to avoid interest, but balance transfers and cash advances often begin accruing interest from the date of the transaction. That’s why it’s best to only use your credit cards for purchases or balance transfers during a promotional 0 percent APR period.
2. Cardholder fees
Credit card fees come in various forms, including:
- Annual fees. The price you pay each year to carry the card.
- Late fees. What you pay when you miss the due date for your minimum payment.
- Cash advance fees. A fee for borrowing cash from your credit card, such as using it to withdraw money from an ATM.
- Balance transfer fees. What you pay when you move debt from one credit card over to your new card.
- Foreign transaction fees. A fee assessed when you make purchases in a foreign currency with your card.
Unlike with interest, fees associated with credit cards are not always avoidable.
For people who have a limited credit history or poor credit, subprime cards with fees may be the only option available. On the other hand, many top rewards cards will also come with high annual fees — though savvy cardholders can offset the fees in rewards and perks.
3. Merchant fees
For the average consumer with a credit card, interchange fees may be the least familiar on this list. However, if you’re a business owner or merchant of any kind, interchange fees will be all too familiar.
Every time a credit card is used to pay for a good or service, the merchant will be charged an interchange fee (also referred to as swipe fee) usually ranging from 1.5 percent to 3.5 percent of the total charge. The name “interchange” refers to the complex payment network that facilitates these charges. And the fees associated with it vary, based on the number of transactions processed by the merchant.
In an effort to lower swipe fees, lawmakers introduced the Credit Card Competition Act in 2022 and again in 2023. While nothing has passed yet, this bill seeks to encourage more competition for credit card processors to lower swipe fees.
The legislation could have an impact on credit card rewards.
“In many studies on the Australian market, where the Reserve Bank imposed interchange price controls, few, if any, consumers benefited from the mandated reductions,” says Brian Riley, co-head of payments for Javelin Strategy & Research.
Bankrate’s Rossman also foresees potential negative side effects for consumers if the bill is passed.
I’m concerned that the Credit Card Competition Act would have major unintended consequences for consumers. It could limit rewards, undermine data security and curtail access to credit. The name sounds friendly enough, but I believe it would be a bad deal for the average American.
— Ted Rossman, Bankrate Senior Credit Card Analyst
3 tips for avoiding extra fees
Knowing what fees ultimately pay for credit card rewards means that you, the cardholder, can take steps to avoid paying any unnecessary fees and, therefore, reap the full value of your rewards.
1. Know what you’re signing up for
Before choosing your next credit card, make sure you know the annual fee and interest rate associated with the card. High annual fees are one of the most avoidable costs of a credit card, and many great rewards cards charge no annual fee.
That said, if you like what an annual fee card has to offer, it’s important to make sure your rewards will offset the cost.
“Some airline cards offer perks like free checked baggage, memberships to ride-sharing VIP programs or airport lounge access, and those perks can be really valuable. But if you rarely use the card, don’t earn many points, don’t use any of the perks and pay a hefty annual fee every year, you might actually be losing money.”
— Dan Stous, CFP and lead wealth advisor at Flagstone Financial Management
Money tip: If your rewards card offers a welcome bonus, fulfilling the requirements and earning the bonus could help you offset the cost of the annual fee for at least a year or two. Plus, maximizing the rewards program can help you continue offsetting any fees long term.
2. Always pay your balance in full
Added interest can quickly change a credit card from a useful tool to a financial burden. Credit card issuers profit from interest, and some of the most common fees associated with credit cards are linked to late payments. With any credit card, only spend what you are realistically able to pay off in a month, or you run the risk of losing money rather than realizing value from your rewards.
If you need to use a credit card for a large purchase and you know you’ll need to carry a balance, consider planning ahead with a credit card that offers a 0 percent introductory APR on purchases. These cards won’t charge you interest on purchases, typically for a set introductory period of 12 or 18 months.
3. Stay away from cash advances
A cash advance can seem like a great option to get money quickly, but cash advances are always associated with a steep cost. In addition to steep interest rates, credit card issuers can charge a 3 percent to 5 percent fee on the cost of the advance, which can add up quickly.
Unlike normal purchases on your credit card, there is no grace period before interest begins accruing on a cash advance. As a rule of thumb, it’s best to avoid cash advances unless absolutely necessary.
The bottom line
Credit card issuers are able to offer lucrative rewards credit cards because of the interest and fees they collect from customers and merchants. Therefore, the key to making the most of your rewards credit card is to avoid paying interest, which will almost certainly outweigh your rewards yield.
Also, be mindful of the fees associated with your credit card — whether it’s an annual fee, balance transfer fee, foreign transaction fee or cash advance fee — to make sure the benefits of your card come out ahead of the costs. While paying an annual fee is often worth it to get access to generous rewards, frequently paying other fees on your credit card will likely erase your rewards earned and essentially pay for someone else’s.
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