There are rewards credit cards that put free gas in your car, groceries in your fridge, movie tickets in your wallet and points to travel with. However, if you’d prefer to earn a dollar rather than a point, you may want to consider getting a cash back credit card instead.
What are cash back credit cards?
As the name suggests, cash back credit cards provide a cash rebate when goods and services are purchased. The actual cash can take the form of either a monthly credit on your statement, or a cheque in the mail after every milestone or year you have it. Like any rewards credit card, because the cash back is something you earn, you don’t want to rack up your card with more debt than you can afford to repay each month; the interest you would end up paying would quickly wipe out the cash back you’d received.
How do cash back credit cards work?
In the credit card agreement for a cash back card, the issuer will specify the rewards based on specific purchases; it is expressed as a percentage and can vary depending on what you buy. For example, the Scotiabank Momentum VISA Infinite gives you 4.00% cash back on gas and groceries but only 1.00-2.00% cash back on all other purchases. If you usually pay for gas and groceries with cash, it could literally pay to use a cash back credit card instead.
One thing to consider before you fill out a cash back credit card application is the fact that the best cash back cards typically come with an annual fee. For that reason, you’d want to make sure you used the card often enough that the cash back reward would offset the annual fee.
Example: Jane's Cash Back Rewards
Jane has a cash back credit card that pays 4.00% on groceries, 4.00% on gas and 1.00% on all other purchases. For the month of July, she buys $500 in groceries, $350 in gas and $250 on dinners and entertainment. How much cash back did she earn?
In the month of July, Jane earned $36.50 in cash back rewards, which is 3.22% ($36.50 / $1,100.00) of her spending.
Example: Jane’s net rewards after interest is charged
Let’s carry forward the same example. However, assume that for the month of August Jane carries a balance of $1,100.00 at an annual interest rate of 19.99%. What will her net rewards be after deducting the interest charges?
First, to calculate the interest charges, we take the outstanding balance and multiply it by the annual interest rate to find out the annual interest charge. We then multiply this number by the number of days she carries a balance and divide it by the total number of days in the year:
Jane has to pay $18.68 in interest. In order to determine what her net rewards will be, we first need to calculate what her cash back rewards will be for the year. Assuming her spending stays the same each month:
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In total, Jane would earn $438.00 in cash back rewards in one year. However, after subtracting the interest charge she had to pay in August, her net reward is $419.32.
Pros and cons of cash back credit cards
While the pros may seem obvious, there are some other things to consider about cash back credit cards before you sign up for one.
- The obvious advantage of a cash back credit card is that it puts money in your pocket with each purchase you make. Most cards offer between 1.00-4.00% cash back
- Some cards have a maximum cash back amount they will pay you per month. For example, a card could pay 1.00% cash back on purchases up to $1,500.00 per month, but nothing above that amount. In this case, your maximum cash back is 1.00% of $1,500.00 = $15.00 per month. If you consistently spend more than this amount, look for a cash back card with either a higher maximum or no maximum at all.
- Cash back cards, like many rewards cards, can tempt you to overspend. Given that you make money every time you put something on your card, there is an incentive to spend beyond your means. If you find yourself buying things you don’t really need, it’s possible that you’re overspending because of the cash back reward.
Cash back credit cards can be great choice, if used correctly. The way to use them to your advantage is to find one with rewards tailored to your spending habits, and always pay off your balance in full so you avoid interest charges; this way, you’ll get maximum rewards without the interest costs.