How Does Cash Back Work? Key Things To Know

How does cash back work?

Ever been enticed by a cash back or rewards credit card offer? Are you currently using one? How does cash back work? If you are considering or using a cash back or rewards card, then it's important to understand how they work. It's also important to understand the true cost of these types of cards and how to leverage them to your benefit.

What does cash back mean?

Cash back is basically when you get money back for making a purchase. Cash back cards and rewards credit cards are pretty much based on the same idea. You get something back when you spend money using your credit card.

The main difference between the two is that with cash back credit cards you get a percentage of the money you spend on a specific category back. For example, you might get 2% cash back on gas or 1% cash back on groceries.

On the other hand, rewards cards offer you some sort of rewards, like points or gift cards. Travel rewards or miles cards are a popular type of rewards card.

Are cash back or rewards credit cards a good idea?

The thing about cash back rewards cards is that they might seem like a perk, but they are also a strategy that credit card companies use to get cardholders to spend more money.

Let me explain. If you are motivated by an incentive, like cash back or rewards points, you are more likely to shift your focus to wanting to obtain as much of the incentive as possible. That can lead to overspending, especially on what you might consider low-cost or cheap items. But in the long run, those can add up too.

This strategy is beneficial to credit card companies because it allows them to make money from interest accrued on credit card balances. And since the cash back rewards they offer are typically much less than your accrued interest, they almost always win when you compare the two.

Cash back rewards cards are only a good idea if your use of them is in line with your budget and you are able to pay your balance.

The fees can get you

Another thing to keep in mind is that cash back cards may actually have a fee involved. These fees could be monthly or annual fees. Depending on how high they are, these fees can eliminate the value of the cash back rewards you get. So it's also important to factor in your fees, spending and  budget when determining if a cash back card is a good idea.

How does cash back work to your benefit?

A cash back card can work to your benefit. You can do this by leveraging it to pay for things that you know you can pay for in full at the end of the month. This means tying your spending on your cash back card into your budget as mentioned earlier.

This way, you know exactly how much you can afford to spend in order to pay your balance off in full each month. And you can resist the temptation to overspend just to get cash back or reward points. Points that you could end up paying dearly for in interest fees later on.

What about credit cards with 0% introductory offers?

Some credit card companies might offer an additional incentive with their cash back rewards cards. They do this by advertising 0% interest for an introductory period of time. Before you take them up on that offer, be sure to ask about annual fees. You also want to know what the interest rate will be after the introductory period is over.

Chances are, if you carry a balance from month to month, you'll be paying back those cash back rewards and then some in the form of interest once the introductory period is over. And possibly in annual fees too.

In summary

When it comes to cash back cards, it's all about being mindful of how you use them. The last thing you want is for reckless use of them to derail your financial goals. You als don't want to find yourself racking up unnecessary debt because you are chasing rewards.

Be sure to build your spending into your budget and plan to pay your balance off in full each month. Consider cash back rewards simply as what they are - a perk.

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