all about rewards credit cards (guest post)

Are rewards cards really that great? Should you shell out an annual fee to carry one in your wallet? Will they give your credit score super powers? Here’s an overview of all things rewards-card related, so you can decide their true worth for yourself.

Rewards cards rack up perks, but…

Okay, your rewards card may earn you enough miles to get to Hawaii once a year, but what are you really paying for that trip? Do you make credit card purchases simply for the rewards points? If so, those points are costing you debt you wouldn’t normally take on. Not very smart. But, if you were going to buy something anyway, and it happens to earn you some rewards points on your credit card, great!

The ratio of dollar spent to reward point earned will always tip in the credit card company’s favor. A good rule of thumb is to only charge what you would have charged otherwise, rewards or no.

Beware annual fees

Another way rewards cards can cost you is if the credit card company charges an annual fee on the account. I personally loathe credit cards that come with annual fees because the rewards are not usually worth it. Some people view elite rewards cards that carry hefty annual fees as a status symbol. I say let them have their prestige, and I’ll hold onto my cash, thank you very much. There are plenty of rewards cards out there that don’t charge annual fees.

If you don’t qualify…

If you can’t qualify for a rewards card without annual fees, focus on improving your credit score and stick to a debit or a secured card in the meantime.

Note that some people with lower credit scores may be able to obtain a rewards card, but they may have to settle for a higher interest rate. You’ll have to decide if the rewards are worth this higher interest rate (in most cases, the answer should be no). However, if you’re one of those responsible people who pay off the entire balance each month, then the interest rate is a non-issue.

Use a rewards card to boost your credit score

Like other credit cards, rewards cards can either bolster or destroy your credit score. Using them responsibly will earn you credit score points plus land you the cool perks. Here are some tips for getting the most out of your rewards card:

  1. Read the fine print. Know the card’s APR, annual fee (if any), and the length of the card’s grace period before applying so you don’t get into trouble later on.
  2. Don’t apply for multiple credit cards at once. Only apply for a new rewards cards if you really need it or if you are unsatisfied with your current cards. Multiple credit applications in a short time period can hurt your score.
  3. Don’t charge stuff just to get the rewards points. This will land you in more debt than you can pay back.
  4. Don’t pay an annual fee for a rewards card. They’re not worth it, and don’t have any extra benefit to your credit score.
  5. Don’t max out your card. A high utilization rate will hurt your credit score.
  6. Pay your bill on time each month. This is the single most important thing you can do with any credit card to help your score.

Choose the right card for you

When you’re ready to apply for a rewards card, make sure you choose one that has benefits you’ll actually use. Here are the main rewards card options:

Cash back credit cards: Some of these offer annual cash rebates that equal some percentage of the previous year’s purchases. Others not only offer cash back, but airline miles, gas rewards, and other perks.

Reward points credit cards: These are similar to cash back cards except you’ll receive “points” instead of dollars. Some cards offer points on every purchase you make; the more you spend, the more you earn. Gas companies and retailers often offer rewards points cards.

Airline credit cards: These are only useful if you do a lot of traveling. Airline cards are not good for those who carry a balance from month to month, as the interest rates tend to be high. These cards offer a form of points or air miles that add up to free flights for card holders. Beware of blackout dates and other restrictions when you go to redeem your miles, though.

What’s in it for the creditor?

As an aside, you may be wondering how credit card companies afford to give you these perks? If there is no annual fee for the card, and you’re one of those customers who pays down their balance in full each month, isn’t the credit card company losing money on you? No, actually.

Credit card companies make money several different ways; interest and annual fees are only two of their revenue streams. Credit card companies also charge a percentage of each transaction to the merchant selling you the service or product. So even if you pay off your balance each month, your creditor is still getting money from these merchant transaction fees.

A final note

Before you get too excited about a rewards card, keep in mind that you might see more “rewards” by not using a credit card at all. Studies have shown that using cash instead of credit is likely to result in at least a 12% savings. For whatever reason, we are more hesitant to part with our cash than to whip out a credit card. So while a rewards card that offers 1% cash back has its place for online purchasing and to help us build a good credit history, using old-fashioned paper money is probably better for your bottom line.

Carrie Davis is a personal finance blogger at SpendOnLife.com, a site dedicated to giving readers true and accurate information about credit, debt, and identity theft. She is FCRA-certified and has a passion for educating others on how to achieve financial independence. Follow Carrie through the SpendOnLife RSS feed or on Twitter @SpendOnLife.