How do credit card rewards work?
In: Economics
You get rewarded for using your credit card on eligible purchases. Could be anything, discounts, gift cards, VIP passes, or straight up cashbacks. It’s a way to encourage you to spend, pretty much.
Rewards usually come in the form of cashback, or airline miles or hotel points most commonly. Basically with each dollar you spend, you get a certain amount back in the form of cashback or points. Say 3% cashback when you buy groceries. Or 2x (per dollar) miles when you eat out at a restaurant.
Each card will have their own rules and specifics though. Definitely read all of them before choosing a card.
Credit card companies make money 2 different ways:
1. Every transaction, they charge the store a small fee for processing the card.
2. Many, many people carry a balance and pay interest.
The interesting part here is because of (1), even if NOBODY is paying interest, there is still revenue for the credit card company. So in order to make the most money, they need as many people using their credit cards for as many transactions as possible.
That’s why they offer rewards. To get rewards, you have to use your card. They make money if you use your card. The way it works out, they’re making more money than they’re giving back for rewards. It’s also true that:
1. Many, many people are paying interest.
2. Many people don’t pay attention to their rewards and let them expire.
This is also why some cards only offer rewards for certain purchases and may change the eligible purchases frequently. In those cases, the stores and the card company are making deals. The stores want more business, so maybe they agree to pay slightly higher fees in return for being the “special” rewards case for that period. They hope that their business increases enough to make up for the slightly lower profit. It kind of works and kind of doesn’t. Some people put off certain purchases UNTIL a deal like this pops up. If there weren’t deals like this, they’d be buying it anyway, so all the deal did was change when they purchase it.
There’s one downside to all of this. It’s theorized that the companies’ fees are higher due to rewards programs. And since that fee is part of every transaction, it’s theorized that stores have had to adjust their prices to account for the fees. So some people argue that credit card rewards programs have raised all prices and made things worse for people who don’t have or use credit cards.
It’s all kind of goofy.
You purchase things on your credit card and the merchant pays the credit card company processing fees of like 3% of transaction. They turn around and give you 1%, while using the other 2% to run the business.
Latest Answers