Credit card cash-back rewards and large sign-up bonuses are some of the most coveted cardholder perks. Both can be powerful tools that can help you earn cash back on everyday purchases or secure cheap travel abroad.
But there are several credit cards traps to be aware of, including how fees can eat away at rewards, qualifications, and impacts to your credit score.
With this in mind, Motley Fool analysts Michael Douglass and Nathan Hamilton talk more about cash-back credits cards and sign-up bonuses in the previously taped Facebook Live video below.
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This video was recorded on March 29, 2017.
Michael Douglass: Hi, Facebook Fools! I'm Michael Douglas, an analyst here at The Motley Fool, and I'm joined by Nathan Hamilton, one of our other analysts, and we're going to be talking to you today about cash-back credit cards, sign-up bonuses, and whatever else is on our mind.
Nathan Hamilton: Everything you need to know.
Douglass: Exactly. First off, before anything else, submit your questions in the comments to have your question answered during Q&A. Let's get started. You're leading up our efforts around credit cards. Talk to us a little bit about why you're doing that, Nathan.
Hamilton: If you look at the history of The Motley Fool and kind of what we've been advocates for, it's going against Wall Street, long-term investing and reaching your retirement goals. You look at how you reach your retirement goals. It comes down to budgeting. It comes down to saving. That has a huge impact in addition to the return you make on your stock investments.
When you look across personal finance, you say, "Credit cards. Are banks being straightforward? Is there an opportunity for us to be advocates?" That's where we see the opportunity in the market specifically with credit cards, because there are just under 2,000 credit card offers on the market. The majority of people out there just don't know where to start, so we want to come out and say, "Here are our picks. Here are our recommendations," and do so that way.
Douglass: It makes sense. You might say, "What do mutual funds and credit cards have in common?" The answer is fees. We know that fees are a major killer in the investing space, whether it's mutual funds and index funds, ETFs, all that, but also with credit cards, whether it's interest, whether it's the hidden fees, sign-up stuff, all that kind of stuff. That can make a big difference in terms of your personal finance. It really does align with our sort of fee-cutting philosophy to be talking about this.
Hamilton: If you look at it, you hit upon a good point, there. If you look at the ability of credit cards and fees, so you have the power to do good, so earning rewards, sign-up bonuses. That is a way to put more money into investing, maybe to take a cheaper vacation. If you look on the other side of it, there's the dangerous side, which is getting into debt, which -- it's very convenient and easy to do so with credit cards. That impedes your ability to save and invest and reach your retirement goals. We want to be advocates for each, for cash-back rewards and also helping people get out of debt.
Douglass: Absolutely. With that in mind, let's go ahead and talk about some general ground rules for credit cards. First off, for a good credit card, just like for a good everything else, you have to have a pretty good credit score.
Hamilton: To be competitive to get some of the more popular offers on the market, generally you're going to have what they consider good credit. Generally with good credit, you're going to be [in the] high 600s and above on your FICO score. As you look at it, the average American is just under 700 depending upon what research you look at. Some say 699. Some say 690.
We can generally assume it's right around that high 600s, which it says, average on average, Americans will qualify for some of the major offers on the market. As you look at it, of course, as your credit score improves, you're going to have access to more premium offers, or bigger sign-up bonuses. There's more points for your regular purchases. Just more lucrative as you move up the FICO score scale.
Douglass: Makes sense. Let's go ahead and also talk about some of the don'ts, here; so, do have a good credit score. Don't think about signing up for a new credit card if you've already got a lot of credit card debt, for example.
Hamilton: Today we're focusing somewhat on cash-back credit cards because it's an interesting topic for many readers, but you've got to look at it, when does it make sense and when doesn't it make sense, because as I mentioned before, credit cards are convenient. It is easy if you don't watch your finances to get further into debt. It doesn't make sense to earn, say, 2% back on a cash-back card and incur interest at 20%. That's a losing proposition. Ultimately, you've got to look at it -- there's two situations. This may determine what sort of credit card you go for. Look at it this way. I've got credit card debt, and I'm going to be carrying a balance and incurring interest charges. Cash-back cards aren't going to make sense for those types of card holders. There are offers on the market, 0% intro, APR cards or balance transfer cards. Those are the good options. Focus there.
Don't so much look at the tantalizing or teasing sign-up bonuses that are exciting when you look at them, but it may not be the right card for you. On the other hand, on the other side of the spectrum, you've got people that are essentially paying off their balances like clockwork each month. They don't incur interest charges, and they harvest the full value of the cash-back rewards. For those people, it does make sense to look at the cash-back cards. Travel cards are also options as well.
Douglass: Cool. Let's also talk about...again, here at The Motley Fool, we're really concerned about fees. Let's talk about annual fees for a minute, because you see with credit cards, sometimes those really lucrative cash-back bonuses come with annual fees. What's your general sense of that? What's the right call, here? You might get -- I'm just making this up -- $500 cash back, but you've got a $100 annual fee. Does that make more sense than another? Help us. Walk us through that calculus a little bit.
Hamilton: You've got to run your budget numbers. That's the first thing, so it's going to depend upon each person's situation. I would venture a guess in our recommendations by us toward this, but I would venture a guess that people are going to be better off with either a no annual fee credit card or a low annual fee credit card.
Douglass: $49 a year, or something like that.
Hamilton: Yeah. There are a number of cards on the market, many that are no annual fees, so there are good options out there. There are many that are below $100. Then you go to the premium credit cards that require the high FICO scores, excellent credit. You've got to be mid 700s and above to even start qualifying for them.
Essentially, in those scenarios, you may be paying $400-$500, but if you've got a large credit spending budget, if you're paying off that balance each month to avoid interest charges, you actually may come out ahead, earning those better rewards. It does depend upon your personal situation, but I would say for the majority of people, and as I mentioned before, our recommendations are going to bias toward what's a fit for most people that may have maybe modest credit spending budgets. That's going to be toward no annual fee and low annual fee offerings.
Douglass: Sort of closer to your average American. You talked for a minute there about avoiding interest rates or interest charges. That's particularly importantly for cash-back cards because they tend to have pretty high APRs.
Hamilton: If you look at it...it's kind of funny, because with every good benefit with a credit card, there's something to make up on the other side.
Douglass: There's a give and take.
Hamilton: There's a fee. Very much a give and take with credit cards. No doubt that's the case with cash-back cards. The average APR on a cash-back credit card is just around 20%. If you look across the categories of travel credit cards, student credit cards, points, rewards, all the various cards out there, that is the highest rate in each category. As you look at it, sure, credit card companies are paying out rewards. That's money out of their pocket. They've got to make it up some other way.
It's just the economics of the credit card businesses. As you look at it, interest income alone is the single largest driver of the credit card business model. That's where they make the majority of their revenue. Cash-back credit cards...if you do get into debt, you're going to be hitting or incurring very high interest charges.
Douglass: Of course, where possible, you don't really want to be helping the credit card company out, here. You want to make sure that you're paying off your balance so that you're not part of that massive several billion dollar a year number.
Hamilton: It is interesting. Even as you're making those purchases, you're still helping the credit card company. It's understandable they need a cut. Essentially every transaction you're making, they're taking a percentage of that, so they do make money off that as well.
Douglass: That sounds good. Again, going back to sort of the average or the typical American -- however you want to slice and dice that -- let's talk about what people can generally expect credit card-wise. You and I have talked about this before. It's usually 1.5%-2% cash back for most purchases, or something like that. Of course, that depends on category a little bit.
Hamilton: We'll look at what they can expect, what most card holders can expect on the cash-back rate, and also on the sign-up bonus, because that is something important to it as well. On the cash-back rate, you've got two options. You've got your flat-rate cash-back cards, and then you've got your bonus category cards. Flat-rate cards, there are a number on the market that are no annual fee, super high-quality cards from established brands that are 1.5% and higher. You're going to cap out around 2% for some cards.
As you look at the bonus category cash back, the base rate for non-bonus categories is going to be 1% almost across the board. Everything else varies, so there are cards that offer bonus cash for Amazon purchases, for gas, for groceries, for utilities, for entertainment, whatever you need. There's MLB cards, there's NHL cards, there's everything out there for any bonus category purchase.
Look at it this way. If listeners are thinking what kind of card makes sense for me, I would look at if you're good with managing credit, or you're good managing your budget, then look at perhaps one to two credit cards. In that scenario, make sure those credit cards fit the majority of your budget. To me, personally, I'm a hockey guy. I love the NHL, but I don't spend a huge amount of money on NHL.com purchases.
For me to get an NHL card that offers 10% cash back and 1% cash back on all other purchases...I should say 10% cash back on NHL.com purchases. It doesn't really make sense for my budget. I would actually be losing out, because I could get 1.5% or 2% for all of my purchases, so run your budget numbers to see.
Douglass: Fortunately, there are a lot of good apps out there that can help with this sort of thing, like Mint, and a lot of banks actually have pretty good personal finance software too. You're good at paying your bills, you're good at managing your debt, but maybe you don't know exactly where you're spending, these sorts of things can help, and then you can say, "We dine out a lot. Wow. We dine out a lot."
Hamilton: That's where my money goes.
Douglass: Absolutely. Whatever the case may be. Let's find a card that aligns with that. Now, I've also seen a lot of cards do these sort of rotating things. January to March it's grocery stories. April to June it's restaurants. How do you keep track of that sort of thing to make sure that you're keeping track of those rotating categories, and making sure the card still makes the most sense for you?
Hamilton: Generally, you're going to have to opt in and activate those cash-back categories. My preference personally, and this may not be everybody else's mantra, but my preference personally is I don't like to have to take additional action to follow my finances and keep on track of what bonus category is earning better cash back. Our ratings tend to actually bias toward cards that have established bonus cash-back categories instead of rotating quarterly categories.
If people are on their finances and don't mind the additional leg work of opting into categories, which is fairly easy to do...generally credit card issuer will send you an email and say, "Hey, activate this. You're good to go." For those people, it can make sense, and the juice may be worth the squeeze, because if they're earning 5% cash back on grocery purchases for the quarter, at wholesale clubs, if you've got a big budget there, it definitely can make you come out ahead.
Douglass: Sure. Of course on the flip side, there's the tendency to be like, "I'm going to get 5% back if I spend more on blank..."
Hamilton: I'm going to go buy a bunch of stuff on Amazon.
Douglass: Right, which, maybe that's not stuff you actually needed. Maybe it is stuff you needed, and you've been putting it off because you knew this was going to come at some point, and if so, hey, good on you, but if it's like, this thing supposedly costs $1,000, but it really only costs $900 now -- that's really not a great way to do it.
Hamilton: I'd look at it this way. If I were to break down a budget and give a credit card consultation, I'd look at the top two to three categories where you spend money, and then get a credit card or two that fits within those categories, and let the other stuff just fall by the wayside, earn cash back, whether it's 1%, 2%, whatever the rate is. I would say that the actual results you're going to generate from getting that additional incremental benefit with cash-back cards probably isn't that much.