How do cash back credit cards work?
Cash back credit cards are one of those products where the name gives you an accurate idea of how it works. When you use a cash back card, you earn a percentage of the transaction amount as cash back. The exact percentage depends on the card and, with certain cash back credit cards, the spending category of the purchase. For example, a card could earn a higher percentage back when it's used at an office supply store or a restaurant.
Let's say you spend $100 with a cash back credit card that earns 1% cash back. You'd earn $1 in cash back. If that card had a 2% cash back rate, you'd earn $2. You'll continue accumulating cash back until you decide to redeem what you've earned.
Most, but not all, transactions will be eligible for cash back. Card issuers typically don't let you earn it on cash advances and balance transfers. You may also not earn cash back on purchases of cash-equivalent items, such as gift cards, and person-to-person payment services, such as Venmo. Any of these exceptions will be spelled out in your card's terms and conditions.
How to redeem cash back
You can redeem cash back through your online credit card account or by contacting your card issuer. Some credit card companies have redemption minimums, such as $20 or $25. Fortunately, quite a few card issuers now let you redeem any amount of cash back with their credit cards.
Redemption methods vary, but generally include one or more of the following options:
- Statement credit: Apply your cash back to your current credit card balance. This tends to be the easiest option, unless you don't use your card much and have more cash back than your current balance.
- Bank account deposit: Deposit your cash back into a bank account that has been linked to your credit card.
- Check: Receive a check in the mail for your cash back.
- Gift card: Use your cash back to buy a gift card. Even though cash is more useful than a gift card, stores occasionally run deals where you can get gift cards for less than face value.
The different types of cash back credit cards
There are three types of cash back cards, with the difference being how their cash back rates are set up.
Flat-rate cash back credit cards
A popular choice if you're only looking to carry one credit card, a flat-rate cash back card earns the same rate on all your spending. While 1% used to be the most common cash back rate, 1.5% has become the new standard for flat-rate cards.
The drawback with these cards is that there's no potential to earn a higher bonus rate. You could be leaving money on the table if you usually spend a lot in a specific spending category. The good news is that you'll earn a solid rate every time you use your card.
Bonus category cash back credit cards
With bonus category cash back credit cards, the amount you earn depends on the purchase. These cards can earn 2%, 3%, or more on qualifying purchases in select, fixed spending categories. For example, if you have a credit card that earns 3% back on gas, you'd earn $3 on a $100 gas purchase.
Some cards put limits on how much bonus cash back you can earn. You may find cash back credit cards that offer bonus rates on up to $1,500 in purchases per quarter or $6,000 per year. Others have unlimited bonus categories. Either way, all non-bonus spending will earn a flat rate, which is usually 1%.
If you find a card with bonus categories that fit your spending habits, then you could earn quite a bit extra using it.
Rotating bonus category cash back credit cards
These cards work the same way as the cards above, only the bonus categories change at predetermined intervals, most often quarterly. So, your card could earn 5% back at restaurants for three months, and then earn 5% back at grocery stores for the next three months.
Your credit card company may provide all the bonus categories for the year ahead of time, or they might only release them at the start of a new quarter. You will usually need to activate those categories with the card issuer to earn the bonus rate for that quarter.
The biggest benefit with these cards is that they often have the highest bonus rates. However, there's no guarantee the bonus categories will be areas where you spend much money. For this reason, consumers often get a flat-rate cash back card to pair with a rotating bonus category card.
What to look for in a cash back credit card
With all the cash back credit cards available, it can be overwhelming trying to choose one. You can make the decision easier by boiling it down to a few important features.
Cash back rate: Everyone wants the card that will earn them the most back. I recommend going over your monthly expenses, figuring out where you spend your money, and picking a card with cash back rates that match your spending.
Annual fee: If you're not too keen on paying an annual fee for a credit card, you'll be happy to know that most cash back cards are no-annual-fee cards. There are a few that charge an annual fee, but they also typically have higher cash back rates.
Sign-up bonus: Many cash back cards have sign-up bonuses. A sign-up bonus can also be called a welcome bonus or welcome offer. These are a nice way to earn even more back shortly after you get the card. The most common type of sign-up bonus involves meeting a spending minimum. For example, certain cards offer $200 in bonus cash if you spend $500 in the first three months from opening the account.
