I’m researching to open my first proper card and still confused about how cash back works.
Say you buy a burger and get 2% cash back. Does it apply a 2% discount to the burger? Or do I earn 2% of the burger’s price?
Where does the money for the cash back come from? Does the cash back affect credit score?
In: Economics
For some cards, the “cash back” is in the form of points, which you can only use for specific purchases made with the card. I have a travel card, for instance. So for every $100 I spend (on anything) I get points that can be used to refund me $2 on travel expenses. Every two or three months, I log in it shows me a list of “travel expenses” which is pretty broad. Suppose I have $200 worth of points built up (from $10,000 of spending on my card). Two months ago I stayed in a motel and it cost over $200. I click that and my points balance goes to zero and my payment due drops by $200.
Depending on your lifestyle and means, this can basically generate a 2% discount on everything you buy. I use my credit card for everything. I don’t travel a huge amount, but there’s enough stuff that counts as travel that I can basically always find something to convert the points.
Two interesting anecdotes:
Years ago I worked at a small company that had to buy very expensive items (~ $10,000) every few weeks on behalf of the US govt. We’d buy them and then bill the government, and get paid in a few weeks. — guaranteed. I and one other senior guy just kept bumping our credit limits up and did all the buying on our personal credit cards. I probably spent $200,000 per year on that stuff. I usually got my money back before the next credit card bill, so I could always pay the credit card balance down to zero, so I never paid interest. But I got 2% of $200,000 = $4,000 in credits.
Second anecdote: I bought a car recently. They were careful to explain that if I used my credit card to buy it, they would tack on a 5% processing fee to prevent that kind of loophole where I get a 2% discount because the bank charged them 5% for the transaction.
You will accumulate 2% of what you pay on your account for that card.
You will log in and see a rewards section that says how much you’ve accumulated in rewards. It will sit there being added to as you use the card until you decide to apply it towards something the company lets you. What they let you spend the rewards on depends on the card. Just some examples:
* Put it towards your statement balance
* Buy gift cards through the company and they mail them to you (sometimes cheaper than buying in store)
* waste them on sweepstakes or chance at other “prizes” (please don’t do this)
* Pay for flights (if it’s a miles card)
Using it to pay down your statement balance basically turns the cash back into a discount.
The money comes from the card company to entice you to use the card. The card company makes money from the shops each time you swipe the card. So by giving you 2% cash back, they earn 3-4% from the shop.
Also the more you use the card, the better chance of you not paying the balance, and they earn money off you in interest.
Cash back does not effect credit scores and it’s not treated as taxable income since it’s restricted to that company and is not actual cash.
Check your credit card agreement, but on my card, when I make a qualifying purchase, a percentage of the amount charged goes into an account with the credit card company. I can then choose to use that to pay some of my balance or get other things through their program. I don’t have an option for them to just give me cash, but the statement credit is basically the same thing.
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