Read These 5 Facts Before Choosing a Cash-Back Credit Card

how does cash back work

A majority of Americans — about 70 percent, according to CreditCards.com — have at least one credit card. Most millennials, in fact, have two credit cards to their name.

If you’re also packing plastic, one of those cards might offer a cash-back rewards program. Cash-back cards, as the name suggests, give you money back in exchange for your purchases.

So, how does cash back work on a credit card, and how do you choose the right cash-back card for your wallet? Before you pick one, make sure you understand these five things about cash-back credit cards.

1. They give back a percentage of what you spend

Cash-back credit cards work like a rebate; they pay you back a certain percentage of what you spend.

“Cash back is the simplest type of rewards there is,” said personal finance expert Sarah Hollenbeck. “The math behind it is so easy, in contrast to the more complicated points and miles cards out there.”

Let’s say you sign up for a credit card with a 1.5 percent cash-back rate, like the Capital One Quicksilver Cash Rewards card. For every dollar you spend, you’ll get $0.015 back. If you spend $1,000 with the card, $15 will go back in your pocket.

Now, this arrangement is obviously beneficial to the consumer. But how does cash back work for the credit card companies that offer it?

Credit card companies aren’t losing any money by offering cash back — they’re just sharing a fraction of the interchange, or processing fee, they charge merchants. When you charge $100 to your credit card at a store, for example, the merchant only gets $98 or so. The credit card takes the remaining $2 in fees.

Credit card companies share a portion of that interchange fee to attract and keep customers. They still make a profit, and you earn a small percentage back on your purchases.

2. Some rewards programs have rotating cash-back categories

Some cash-back credit cards offer a flat rewards rate on all your purchases. The Citi Double Cash card and Blispay Visa, for example, both offer 2 percent cash back on your purchases.

But other cards make things more complicated by offering multiple rates for different spending categories. The American Express Blue Cash Preferred card, for example, gives you 6 percent cash back on groceries and 3 percent on gas and select department stores. All other purchases have a rewards rate of 1 percent.

The Chase Freedom card, meanwhile, rotates its categories every quarter. Every few months, you’ll get 5 percent back in a new category, whether it’s restaurants, grocery stores, or gas stations. If you forget to activate the category, you’ll still get 1 percent back on all purchases across the board.

Note that some credit cards will set limitations in some categories. “Some cards let you earn extra cash back (5 or 6 percent) in certain categories, like groceries, but will cap the amount of cash back you can earn in those categories per quarter or year,” said Hollenbeck.

If you enjoy maximizing your rewards, you might benefit from a card with variable cash-back rates. But if you’d rather not worry about where you’re spending your money, a flat-rate rewards card could be the better fit.

3. You might have different options for redeeming points

How does cash back work when you’re ready to redeem your points?

“That’s easy, too,” said Hollenbeck. “Log in to your account. You’ll see how much cash back you’ve earned. It will be shown as a dollar amount. You can generally redeem all or some of it at a time, and, depending on the card, you have various ways of redeeming.”

Most companies offer one or more of these ways to cash out:

  • Direct deposit into your bank account
  • Mailing you a check with your cash-back rewards
  • Applying the rewards to your current credit card balance
  • Putting your points on a gift card from a popular vendor, such as Amazon
  • Donating your rewards to a charity of your choice

Some cards require you to have a certain amount of points before you cash out. “Some cards will set minimum redemption amounts — you may have to wait until you have $20 in cash back accrued before you can redeem, for example,” warned Hollenbeck.

Before taking out a rewards credit card, do your research on how and when you’ll get cash back to make sure it’s useful to you.

4. Your APR might be high

Cash-back credit cards tend to be best for people who can pay their balance off in full each month. That way, you can reap the rewards without falling into high-interest credit card debt.

If you do carry credit card debt, a cash-back card might not be for you. Rewards cards typically come with high interest rates. The Citi Double Cash card, for instance, has a variable rate between 14.49% and 24.49%.

Cards with lower APRs typically don’t offer competitive rewards programs. When it comes to cash back or a low APR, you usually have to choose one or the other.

5. An annual fee might not be worth it

Getting money back on your purchases is a tempting offer, but it might not be enough to offset a high annual fee. The Amex Blue Cash Preferred card, for example, costs $95 per year. The Chase Sapphire Preferred costs $0 for the first year but $95 per year after that.

Although some cards lure you in with bonus offers in your first few months, the rewards might not be enough to justify the annual fee. When choosing a card, consider how much cash back you’ll get based on your spending habits.

If the rewards fall below the fee, a card with a lower annual fee — or no fee at all — might be a better match for your budget.

Make cash back work for you

If you’ve ever talked to friends and family about credit cards, you might have encountered a lot of strong opinions. Some people swear you need to avoid credit cards at all costs. Others rave about strategically using credit cards to earn lucrative rewards.

For most people, the best approach lies somewhere in the middle. Credit cards can be dangerous if you’re spending more than you can pay back each month. Cash-back cards tend to have high interest rates, so you should be wary of carrying a balance.

Plus, you don’t want to get tricked into spending more for the sake of earning points. A cash-back program should be a reward for your normal spending habits.

As long as you can exercise self-control in your spending, you could benefit from a cash-back credit card. That is, unless you’re more interested in earning travel points for your next vacation.

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