How Does Cash Back Work?

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Earning cash just from buying what you need seems too good to be true, but it’s easy with the evolution of credit cards. Cash back cards originated in the 1920s when individual firms began issuing company-specific cards to customers for purchases made at their outlets. Whether you spend most of your money on travel, apparel shopping, or a night out on the town, there is a cash back rewards card for you.

How Do You Earn Cash Back on Credit Cards?

A cash back credit card is one that offers cash rewards for spending. Most credit cards offer one to two percent earnings on all purchases, meaning if you spend roughly $1,000 per month, you will earn a total of $10 back. Some credit cards will offer high cash back rates targeted to different spending categories each month.

On most cash back rewards cards, specific high reward categories are capped at a certain rewards amount. For instance, a credit card company may only allow a consumer to earn $1,000 a year in cash back rewards, regardless of how high they build up their bill. Based on the credit card, you can redeem points through direct deposits to your account, gift cards, or a statement credit via check. Some credit card companies will require users to build up rewards to a certain value, such as $25, before cashing out.

3 Types of Cash Back Cards 

When looking into which cash back credit card works best for you, keep in mind the different types and how each can benefit you.

1. Category Bonus Cash Back

Category bonus cash back credit cards accrue rewards by focusing a higher earning rate on one spending category like gas, groceries, or travel and hotels, and one percent back on just about everything else. Cards that reach five to six percent cash back may cap out earnings monthly or quarterly. Different cards have different focus categories. For instance, one credit card may offer more rewards for basic necessities like groceries and transportation, while another offers unlimited cash back for dining and entertainment.

2. Tiered Rewards Cash Back Cards

Tiered rewards cards are similar to category cards in the way they offer five to six percent cash back on purchases in a set category. Maximizing cash back rewards may result in obtaining different cards for different purchases, which can get a little messy. For example, one card may offer six percent cash back at restaurants or bars, while another offers more rewards for office supplies.

3. Simple Cash Back Credit Cards

Simple cash back credit cards are, well, simple. This type of rewards card offers a flat rate, normally around one to two percent, with no specific category requirements. This allows the freedom to use one cash back credit card for all purchases — no headache when deciding which card to use when standing in the checkout line.

5 Things to Consider Before Applying for a Cash Back Credit Card

1. Annual Percentage Rate

The APR (Annual Percentage Rate) of a credit card is the yearly price you pay for borrowing money. On most credit cards you can avoid paying interest on purchases if you pay your balance in full by the due date each month. Most cash back cards have a higher interest rate and annual fee compared to a basic credit card to balance out the cash back option.

Pro Tip: The current average APR is 17.61 percent. Remember, if you pay off your credit card balance before the monthly due date, you won’t have to pay the full interest expense.

2. Fees

Some cash back credit cards charge an annual fee of about $50 to $100 just for you to obtain the card and take advantage of its reward opportunities. The primary reason for this is that some users will earn exponential rewards, so the credit card companies need to make money somehow. Big spenders usually recognize the annual fee as worthwhile when they earn so much.

Pro Tip: Add up the monthly expenses you plan to put on your cash back card and multiply by the card’s rewards rate. Once you have that value, subtract your expected expenses from rewards earned and the annual fee to see if you are at a net profit or loss.

3. Earned Points

With high reward credit cards, companies will cap how many points you can accrue within a month, quarter, or year. Along with that, many card companies will pay back rewards in the form of gift cards instead of actual cash. Being aware of reward payout options can help you decide which card fits your spending needs.

Pro tip: Apply for rewards credit cards based on your spending habits. Whether you spend the most on travel, gas and groceries, or dining and entertainment, there is a rewards card for you.

4. Reward Rates

There are three main types of cash back credit cards: flat, category, or rotating. Most cash back credit cards will offer a flat rate, where rates stay consistent no matter what you buy or where you buy it. Other cards offer higher reward rates specific to spending categories such as gas, groceries, entertainment, or travel. Rotating rates shift earnings to focus on different categories or retailers every month or quarter.

Pro tip: Figure out where you spend most of your money and match that with a cash back credit card that offers high reward earnings specific to that category.

5. Redeeming Points

Different cash back cards offer various ways to redeem your points. Some rewards are available in statement credits, bank account deposits, checks, or gift cards. Along with that, there isn’t a “best time” to redeem your points to optimize your cash back. Some card companies may require a minimum point threshold before redeeming, but allow you to cash out whenever you want after the minimum is met.

Pro tip: Make sure you keep up to date with any rewards that may expire and fully cash them out before they do!

What Credit Score Do You Need to Be Approved?

A credit score is a number between 300 (high risk) to 850 (superprime) that represents how reliable a borrower may be. Credit scores are crucial when determining your approval for loans or credit cards, the interest rate you pay, and what credit limit you are allowed.

There are a few different elements that are under consideration when your credit score is reviewed. These include established credit history, a stable income when the credit application is reviewed, and a credit score that meets the bank’s minimum criteria. To avoid being turned down for a credit card, choose a card for which you have an above-average chance of approval.

One thing to keep in mind when establishing your credit — applying for too many credit cards can actually hurt your credit score. A credit inquiry, or “hard inquiry,” appears on your credit report each time your score is reviewed. This can potentially stay on your record for up to two years, even though it may only shave a couple points off your credit score for up to six months.

More Cash in Your Pocket 

Maximize your cash back earnings by studying your spending habits in relation to each credit card category reward rate. Label each card with a small piece of masking tape that lists the card’s spending categories. This makes it easier to decide which card to use at checkout.

When you use them for all of your spending, cash back reward cards may earn you thousands in extra cash. To get the most out of these rewards, be sure to study which card works for you and your lifestyle, and manage it carefully. If it fits in with your spending habits, it could earn you extra spending money with minimal effort.

Sources: Investopia | Buzzfeed | Credit Cards | The Savvy Couple |

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