Credit cards have a bad reputation among many financial planners. For many, the trap of credit card debt is almost impossible to escape because of high interest rates and onerous fees. Yet for those who vow to pay off their credit card bills every month to avoid any finance charges, the credit card rewards that many card companies now offer have gotten much more attractive than they were in the past. Below, we'll take a look at just how far credit card rewards have come and what you should look at in considering what rewards you want to pursue.
Early credit card rewards
For a long time, credit cards offered no rewards at all to their cardholders. The fact that a credit card allows you to delay paying for the goods and services you buy until the end of the billing cycle is itself a benefit for using cards, and when interest rates were higher in the late 1970s and early 1980s, the financial advantage of getting up to a month of float on credit card purchases was much larger than it is in today's low-rate environment.
Yet credit card companies earn money based on purchase volume, and rising competition among a growing number of card issuers made it necessary to find ways to distinguish one issuer's card offerings from others. Some industry players saw rewards as a way to do that, as well as to drive greater spending.
Discover Financial (NYSE:DFS) was one of the pioneers of the reward-card industry, with its cash-back program paying as much as 1% in cash back to cardholders. Other card companies latched onto the growing frequent-flier mileage programs, offering rewards that were tied to mileage. Slowly but surely, more card companies started to follow suit, and now it's relatively easy to find rewards programs on cards issued by all of the major card networks.
Bumping up the percentages
Historically, to get cashback percentages greater than 1%, you had to be part of specialized programs. For instance, brokerage company Fidelity has offered a program for years that includes a card paying 2% rewards. The reward is paid in the form of a contribution to an eligible brokerage account at Fidelity. Similar programs at other brokerage companies have come and gone over the years.
Lately, though, cashback percentages have risen, even on all-purpose cards. A rising number of cards now offer 1.5% in cash back on purchases. One card offers 2% in total cash back, with 1% credited upfront when you make the charge and the other 1% coming after you pay your bill.
Moreover, there are several cards offering even higher percentages for certain types of purchases. With certain cards from Discover and other financial institutions, certain categories of purchases qualify for 5% cashback bonuses, with those categories remaining eligible for three-month periods and then rotating to other types of purchases.
Other specialty reward cards have permanently higher rewards tied to purchase categories that don't rotate. The American Express (NYSE:AXP) Blue Cash Preferred Card, for instance, pays up to 6% on supermarket purchases, with 3% rewards on gas station purchases, and 1% on most other transactions. Similar cards from other issuers are often tied to different types of purchases.
How to take full advantage of credit card rewards
If you want, you can put together a set of credit cards that allows you to take maximum advantage of cashback offers and other rewards on the mix of spending that matches your lifestyle. Having some general-purpose rewards cards gives you a default to use on your regular spending, and then a good mix of specialty cards with higher rewards for your most frequent purchases can make your card management even more lucrative.
There are two things you must keep in mind with rewards-based strategies. First, it doesn't make sense to spend money on things you wouldn't otherwise need to buy just to get the reward. Card companies like Discover and American Express want you to spend more, but spending an extra $100 just to get $1 to $6 in rewards doesn't make financial sense for you.
Second, to use rewards strategies, you should aim to pay off your card balance every month. Otherwise, interest charges will easily outweigh the cash back or other reward you earn from your spending.
That said, card companies want your business, and it makes sense to grab up as much as you can. By knowing about the ever increasing rewards that credit cards offer, you can make sure that the cards you have in your wallet will work as hard as they can for you.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends American Express. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.