Done right, rewards credit cards can be lucrative and help repair bad credit.
Done wrong, they can be costly and distract you from a different type of card better suited to your needs. So before you apply, get the facts first. How do cash, points, and miles rewards work? How do you compare cards and choose the best one? What kind of credit do you need to qualify? Get answers to these and other commonly asked questions about rewards credit cards.
What is a rewards credit card?
A rewards credit card is one that offers you incentives for using it. The more you charge to the card, the more rewards you get (with restrictions). The particulars of every rewards credit card varies, but the three main types of rewards are:
- Cash back
The type of rewards credit card to look for will depend on which of these incentives works best for the way you spend.
How do cash rewards work?
Cash rewards work pretty much the way they sound like, but with a couple of finer points that are important to understand:
- Every charge made to the credit card won’t necessarily go toward your cash back reward. You will likely have to make purchases in certain categories of spending to earn cash back, and these categories can fluctuate. And, of course, the cash you get back is only a small percentage of what you spent.
- Cash rewards come in different forms. While some cash rewards credit cards will send you a check or deposit money in your bank account, others will give you your cash reward in the form of a gift card. Or they may simply credit that amount back to your credit card (reducing your balance but not counting as a credit card payment).
How do points rewards work?
When you have a credit card that rewards you in points, every dollar you charge to the card gives you a certain number of points that may be redeemed for merchandise, gift cards, or travel related expenses.
How do travel rewards work?
When you have a travel rewards credit card, every dollar you charge to the card gives you a certain number of miles or points that can be used exclusively toward travel expenses, such as airfare, a hotel stay, or a rental car. It varies from one card to the next, but every dollar spent generally converts into one or two miles (or points).
And unlike rewards programs through specific airlines or hotels, you are not limited to where you can redeem your miles or points. That said, if you only fly one airline most of the time, don’t forget to check out how rewards work through their loyalty program.
How do you compare rewards credit cards?
Use credit card comparison sites
We recommend Bankrate, Nerdwallet, and WalletHub. You’ll also see credit card offers through credit monitoring sites like Credit Karma, Credit.com, Credit Sesame, and Quizzle. You don’t have to use them all, but don’t limit yourself to just one source.
Wherever you compare rewards credit cards, look at:
- Earnings percentages
- Points or miles earned per dollar
- Earnings restrictions
- How rewards are redeemed
- Rewards bonuses
Beyond that, rewards credit cards should be subject to the same scrutiny as any other type of credit card you would apply for. Look at:
- Application fees
- Annual fees
- Interest fees
- Balance transfer fees
- Cash advance fees
- Foreign exchange fees
- Late payment fees
- Returned payment fees
And don’t forget to look at the level of credit you need to qualify. Every time you apply for a credit card, it counts as a hard inquiry on your credit report. This alone will only put a small dent in your credit score, but if you’re turned down and have to apply for a different card, multiple hard inquiries over a short period of time don’t look good.
Read the terms and conditions
We’ve all ignored terms and agreement when applying or signing up for something online. Don’t do that with a credit card application. In fact, click on every link you see to “offer details,” “pricing and terms,” “rate and fee information,” etc., to be sure you know exactly what you are getting yourself into.
Use the CFPB databases
The Consumer Financial Protection Bureau (CFPB) maintains two searchable database that can be helpful when you’re shopping around for a rewards credit card (or any other type of card):
- Credit Card Agreement Database where you can search by credit card issuer
- Consumer Complaint Database where you can search by issuer or credit card
This may seem like a lot of work, but you need to know what’s in the fine print and it’s nice to know whether there is a recurring problem with a particular issuer or card.
What kind of credit do you need to qualify for a rewards credit card?
To qualify for most rewards credit cards, you’re going to need good-to-excellent credit, but you will find exceptions. That said, just because you can get a rewards credit card with bad, fair, or no credit, that doesn’t necessarily mean that you should. Yes, having a credit card can help you improve your credit standing, but if you’re in that situation, you may find the lowest fees and interest rates beyond your rewards card options.
How can a rewards credit card help your credit?
The same way any other credit card can — by using it regularly, keeping the credit utilization ratio under 30 percent, paying off the balance every month, and making your payments on time. Learn more about responsible credit card use.
Do you have to carry a balance to earn credit card rewards?
No, you need not carry a balance to earn credit card rewards. You need only use the card. Your goal, in fact, should be to return your balance to zero every month so as to avoid interest charges, a general rule you should give yourself for any type of credit card. This not only helps you avoid fees, but also helps keep your credit utilization ratio low.
Are credit card rewards taxable?
No, credit card rewards are not taxable, as the IRS considers them to be discounts, not income. However, as TurboTax explains, it is possible for credit card rewards to impact your taxes in other ways:
“There may be times when you need to reduce the amount of a deduction to reflect the discount that a cash back reward provides you with.
“For example, suppose you’re self-employed and you purchase a cell phone that you use solely for business purposes. In this case, the cost of your phone is fully deductible on your return. But remember, you can only deduct your actual cost. So if the company charges you $200 for the phone but allows you to obtain a $150 rebate through the mail, you must reduce your deduction by $150. At the end of the day, you only paid $50 for the phone, and this is all the IRS will let you deduct.”
How do credit card companies fund their rewards programs?
In 2011, an amendment to Dodd-Frank meant banks started earning less from debit card transactions. To make up for the income loss, they needed a way to incentivize customers to use their credit cards instead, as the banks make more money on these types of transactions. The incentive? Credit card rewards programs.
As reported by Forbes’ Robert Harrow, “The fees merchants pay for accepting credit card payment fuel rewards programs. These charges, referred to as interchange fees, are higher in the United States than in most countries around the world.
“In 2014, the Federal Reserve Bank of Kansas City reported that the average merchant in the country pays around 1.73% of each credit card transaction to the issuer, card network and other bodies that handle the transaction of funds.”
But merchants aren’t just absorbing the cost. They may be passing it down to you in the form of higher prices or as a surcharge when you pay with credit.
“We found that the best rewards credit cards can give you as much as 2% back on every purchase,” writes Harrow. “However, if the place you’re shopping with tacks on a 2.5% surcharge, you’d be walking away with less money than you would have if you paid cash.”
The takeaway? Use rewards credit cards wisely: 1) compare prices one everything you buy, and 2) if there’s a surcharge for using credit, shop somewhere else, or pay with cash or debit instead.
Are rewards credit cards worth it?
It depends on 1) what you want to get out of them, 2) how well you understand them, and 3) how well you use them. In general, though, rewards credit cards do come with some universal pros and cons.
- When you charge something to a rewards credit card, you get something back
- You can choose the type of rewards that work best for you
- The annual fee may be waived the first year
- They usually come with sign-up bonuses
- As with other cards, responsible use can help improve your credit
- Restrictions apply, meaning not all types of charges will necessarily earn you rewards*
- Qualifying spending categories may fluctuate
- Annual fees (once they kick in) can be high
- You may be tempted to spend more than you normally would just to earn the rewards
- Most states allow merchants to tack on surcharges when you pay by credit card so that they can offset the cost they are charged for the transaction
- If you do carry a balance, high variable interest rates of rewards credit cards can be costly
*Besides restrictions relative to spending categories, don’t expect to earn rewards for balance transfers, cash advances, the purchase of traveler’s checks or money orders, wire transfers, the payment of fees, or unauthorized or fraudulent charges.
How do you choose between rewards credit cards and other types of cards?
As with most consumer products these days, the credit card market is overrun with options, rewards credit cards being just one of them. So as good as it sounds being rewarded for making charges to your credit card, don’t overlook the benefits of cards with other types of incentives.
Rewards should probably not be your top priority if:
- You want to transfer the balance from a higher interest credit card to one with a lower rate. In this case, look for a balance transfer credit card. (Just don’t expect that low rate to apply to new credit card charges.)
- You want to charge a large purchase to the card that you won’t be able to pay off right away, meaning you’ll need to carry the balance from month to month for a while. In this case, look for a zero interest credit card. (Just remember that zero interest is only a temporary offer; pay attention to how many months this introductory offers lasts.)
This doesn’t mean you can’t have the best of both worlds. Some credit cards that are good for balance transfers, or come with zero interest, also come with rewards. WalletHub offers an especially user-friendly way to sort cards with multiple incentives in one search (e.g., zero percent on purchases, zero percent on balance transfers, low regular rate, no annual fee, and rewards by type).