How cashback and rewards cards work, and when they cost you more

A rewards card can make an everyday purchase feel a little less expensive. But the reward is only one part of the cost. A household also needs to account for any interest, fees and spending it would not otherwise have made.

How cashback and rewards cards work

Cashback and rewards credit cards typically return a portion of eligible purchases as cash back, points or miles. Depending on the card, rewards may be redeemed for options such as a statement credit, a bank deposit or a gift card.

A reward is not the same as a reduction in the purchase price at the checkout. To understand its value to a household, consider both what the reward can be used for and what it costs to earn it.

Types of rewards cards

Rewards cards generally use one of three structures:

• Flat-rate cards offer the same rate across purchases.
• Tiered or bonus-category cards offer higher rates in certain categories, such as groceries or dining, and lower rates elsewhere.
• Rotating-category cards change their bonus categories quarterly.

The structure that looks most appealing on paper may not match a household’s spending. For example, a higher grocery rate is less useful in an estimate if much of the family’s spending falls outside the qualifying category.

How rewards are earned and redeemed

Rewards are earned on qualifying purchases. Merchant category codes help determine how purchases are classified, while transactions such as cash advances and balance transfers may be excluded. Interest and fees generally do not earn rewards.

Rewards usually do not expire while an account remains open and in good standing, although exclusions apply. Card terms are the place to check what qualifies, how rewards can be redeemed and whether there are restrictions that matter to the household.

When looking at redemption choices, it helps to distinguish between a reward that can cover an ordinary expense and one that would mainly encourage a purchase the family had not planned. A gift card, for example, has more practical value to someone who already expects to use it.

How interest and fees affect rewards value

Carrying a balance can make rewards costly: interest charges can erase or exceed the value earned. Paying only the minimum or carrying debt for months can make the gap larger. The card statement and terms provide a fuller picture than the rewards balance alone.

An annual fee also needs to be weighed against rewards and benefits the household actually uses. A card can produce a net loss if spending is low or its benefits go unused. Foreign transaction fees are another possible cost on international purchases.

One way to assess value is to start with the rewards a household realistically expects to use, then subtract the relevant fees and interest. That is different from counting every advertised benefit at its maximum value.

When spending for rewards strains a budget

A planned purchase and an extra purchase can look identical on a rewards statement, but they affect a budget differently. If a family buys something it does not need just to earn a reward, the extra purchase belongs in the cost calculation.

Consider a household trying to earn a welcome reward. If meeting the spending requirement means bringing forward purchases it cannot comfortably cover, the reward alone does not tell the whole story. The relevant question is whether the spending fits the existing budget without relying on the reward to make it affordable.

How to assess a card against household spending

A useful starting point is a recent household budget: groceries, transport, bills and other regular purchases. From there, consider:

• Which planned purchases would qualify for rewards, and at what rate?
• Would the household use the available redemption options?
• What fees might apply, and could interest outweigh the rewards?
• Would earning the expected rewards require spending outside the budget?

Use the card’s current terms rather than assuming every purchase earns the headline rate. For help assessing credit costs or choosing an option for your circumstances, consider speaking with a qualified financial professional.