Credit Cards Can Pay You Thousands

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Lots of credit card companies offer their customers rewards for using their cards. If you're careful, those rewards can give you free money. But for many, those rewards simply aren't worth the cost.

The best of all worlds
Some people take reward-grabbing to an extreme. In a recent Washington Post article, Nancy Trejos described how many people use their credit cards to reap rewards -- often in the form of "cash back." It was interesting to me because I'm one of those people.

I've received several checks from my credit card companies over the years, each for between $100 and $300. "Not bad," I've thought to myself, a little smugly. But Ms. Trejos profiled some people who put me to shame:

Michael Cheng and his wife, Nicole, each have four credit cards in their wallets. ... In return for their purchases, they get checks or gift cards: 5% cash back from the [JPMorgan Chase (NYSE: JPM)] Chase rewards card, 3% from Chase business, 5% from [Discover Financial (NYSE: DFS)] and an amount equal to 1% from the Farm Bureau. The Chengs, who have a stack of other cards, keep track of the cash rewards on a spreadsheet: They made $1,121 in 2006 and $1,093 so far this year.

The Chengs do what I do -- use different cards for different purchases. They earn 5% back from a Chase rewards card on gas purchases; I've received 5% back from my Discover card. They get 3% back on certain purchases from their Chase rewards card, and 1% back on all purchases on another card. With my Citigroup (NYSE: C) Citi Dividend Platinum Select card, I get 2% back on purchases at gas stations, drugstores, and convenience stores, as well as for utilities (including cable). I've also earned hundreds back from my Motley Fool credit card.

Rewards are drying up
If you're all fired up to maximize your rewards via credit cards, hold on. There are some downsides to all these big checks.

For one thing, rewards like these are more and more difficult to come by. There used to be 5% rewards on all purchases. I used such rewards to earn hundreds off Apple (Nasdaq: AAPL) products, and I racked up savings of several thousand dollars off my next purchase of a General Motors (NYSE: GM) vehicle -- although I have yet to buy one and may never do so. Until a year or two ago, I was earning 2% to 3% back on most of my purchases.

Now many cards offer tiered rewards, paying you a certain percentage on your first $1,000 in purchases, a slightly higher percentage on your next $1,000, and so on. They're trying to limit their expenses. Some cards explicitly limit how much you can earn each year -- for my Citi card, the limit is $300.

Paying more to earn less
But more importantly, trying to grab rewards can push you in the wrong direction if you're not careful. Consider, for instance, your debt situation. If you carry a revolving balance on your card (in other words, you don't pay off your entire tab each month), you're not doing yourself any favors by continuing to use it. As Trejos pointed out, earning 1%-2% on your purchases while paying 25% or more to finance them isn't a brilliant financial move.

And even if you're debt-free, look at your big picture. The Chengs have an impressive record, as they're reaping more than $1,000 per year. But so far in 2007 they've spent $47,800 to generate $1,093 in rewards -- which is 2.3% of their spending. It's as though they got a 2.3% discount.

Think about that -- in a situation like that, are you spending more than you need to spend just to rack up rewards? That is a psychological trap that ensnares some folks. If the Chengs, for example, spent $5,000 more than they really needed to while chasing rewards, then they paid an extra 10.5% to save 2.3%. That doesn't make sense. They'd have been better off not spending all that money in the first place.

Where to learn more
If you're ready to use credit cards to reap rewards on purchases you'd make with or without rewards, a little research can get you to some good cards. Visit sites such as www.cardratings.com, www.askmrcreditcard.com, and www.creditcardwatcher.com, and you'll see lists of recommended cards for various purposes.

The American Express (NYSE: AXP) Simply Cash card, for example, offers 5% back on gas. The Capital One (NYSE: COF) No Hassle Points card offers two points per $1 spent at gas stations and major grocery stores and drugstores, and one point for every $1 spent on other purchases.

Be a smart credit card user. Learn much more about the credit card industry in our Credit Center and in these articles:

• The 8 Commandments of Credit
• Credit Card Fine Print Can Cost You
• The Worst Credit Card Ever
• Sneaky Credit Card Tactics
• Win the Balance Transfer Game