Rewards credit cards can feel very exciting. Shopping for new things and spending money is fun, and if you get gifts for doing it, what’s not to like? Credit card companies know how to attract customers – rewards are a great way to get them people at the door and try to keep them honest.
What most consumers don’t want to think about are the deals they make when they sign up for rewards cards; Also, your points and miles and cash back are not godsends for specials. Rewards can be earned at a hidden cost, it is common among people with low income and people who pay in cash after all, consumers are paying higher swipe fees for fancier cards, passing on extra cash. But rewards cards also come at a cost for people who, frankly, aren’t very good at using them. With all the websites out there dedicated to ways to game the credit card system, it’s easy to overlook all the ways that, if you’re not careful, are the system is playing you.
Rewards cards are only really useful for customers with regular credit. Poor credit scorers – meaning people with higher unpaid balances or who don’t pay off their cards month after month – end up losing out. They end up financing the rewards of people with better credit, regardless of where they fall on the income spectrum. More than half Credit card customers are “revolvers,” meaning they don’t pay off their balance in full each month.
“It is very important to read financial books,” said Andrea Presbitero, a senior economist in the research department of the International Monetary Fund and one of the authors of a 2022 papers look at rewards and redistribution in the credit market. “Ignorant people, stupid people, make a lot of financial mistakes.”
The kicker: In banking, it doesn’t really matter whether a reward client is good at managing their own money or not. They make money in any way. Let’s break down what Presbitero and his friends found.
If you can’t pay your balance, you may be paying for someone else’s compensation
Rewards cards are a booming business for issuers and are popular with consumers across the credit spectrum. According to the Consumer Financial Protection Bureau’s 2021 credit card market report, even people with “low credit scores” — meaning low credit scores — put more than 60 percent of their credit card purchases on rewards cards, and nearly three-quarters of consumers recently did the same. The highest credit customers are the best rewards to spend electricity. (If you need a complete explanation of the United States scoring system, you can find one here.)
How much money people get for their money, if any, varies greatly along the credit spectrum, according to research by Presbitero and his colleagues. They found that people with excellent credit (those with a FICO score of 780-850, top) on average earned $9.50 in interest and paid $7.10 less in interest each month. in rewards cards compared to run-of-the-mill cards. Subprime consumers, meaning people with scores below 660, will receive only $1.80 in rewards and pay back $6.40 in interest. “We estimate a total redistribution of $15 billion from the least to the most educated, poor to rich, and high to low minority groups, widening the existing disparity,” said their report.
The researchers looked at two specific groups of what they call “naive” consumers who make more mistakes with rewards cards: they borrow too much, and they default on their payments. Credit card in a good way. They focused on rewards cards that offered points, miles, or cash back for dollars spent; the data does not consider benefits such as airport access.
In the first part, they looked at the incremental credit growth on rewards cards, meaning the number of times the bank says something like, “Hey, that’s an extra $1,000 on your credit. limited, intimidating.” They found that such increases led to higher unpaid balances among consumers with low credit scores – they increased their spending because they could, but they were unable to repay the debt.
“If you’re a smart person, you get $1,000 more, you increase your consumption and your spending, but you can’t increase your repayments because you’re holding back,” the said Presbitero. “You will end up with unpaid balances, and on those balances, you will pay interest and fees. Well, yes, you’ll probably get $2 in compensation, but you’ll have to pay $5 in interest.
In the second part, the researchers studied people with multiple cards at the same bank and looked at how customers managed their various debts. They found that low-credit customers “tend to follow a balanced (and expensive) comparison of their credit card repayments,” meaning they didn’t pay down their cards in the best ways. For example, they focused more on cards with higher balances and not cards with higher interest rates, where the debt would be more expensive.
According to Presbitero, the issue isn’t that some customers don’t know the best way to pay off debt and handle their rewards cards, it may not matter to them, or they just don’t care. . “Maybe they’re so rich they don’t care,” he said. “Maybe you’re not smart and you don’t know, or maybe it’s because of what business people call not thinking well; it is right for you not to care.”
Either way, when people switch to rewards cards, they pay a price — and that price ultimately helps pay for the rewards of people who don’t.
In addition, it has a geographical effect. Presbitero and his colleagues have noted, across the board, that earnings are higher in zip codes with higher levels of education, higher incomes, and a lower proportion of Black residents.
The bank wins regardless
Figuring out where to get credit card rewards can be daunting. Yes, it’s nice when you get it, but it’s not inevitable or necessary. Giving consumers a reward for the act of doing capitalism is a bit flawed, and it’s a very distinctive feature of commerce, on the web, between customers, suppliers, and other partners.
The important thing to remember here is that credit card companies and banks are in the business of making money, and they won’t issue credit cards if there’s nothing in it for them. In this case, billions of dollars are on the line.
Advertisers make money on card issuers regardless, across the credit spectrum. The researchers found that banks benefit more from first-time customers and those in the middle of the FICO score distribution. On the high and low end of the FICO score, banks make different payments. For consumers, more than 60 percent of the bank’s income on credit cards comes from interest income. For top sellers, more than 80 percent comes from transactional revenue, meaning swipe fees are paid by customers when people spend. In the middle, banks can make money on both interest rates and swipe payment.
“The bank is clearly the winner here,” Presbitero said. “Regardless of what I do, if I’m a gun or not, if I spend a little or a lot, the bank still gets money.”