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Should I turn down a credit card that offers cash back?

February 1, 2011

With this in your future, how could you turn down that credit card offer?

Credit card debt is bad debt, and the statistics prove it. Of the households that have credit card debt, the average amount owed to credit cards is $15,788. With the average annual percentage on this debt at 14.48 percent, the average household is paying $2,286 each year in interest.

            Most people realize this, but there are many reasons people still open and use credit cards. One of the popular reasons now is that there are perks. People open new credit card accounts to get the bonuses from using the credit card. The rationale is that one can use the card, pay off the balance every month, and then reap the airline miles, cash back, or other perks the cards offer.

            In theory it is a good plan. Individuals get something back, and by paying off the balance every month, they are not charged extra interest. By doing the math, it makes sense. The problem is financial success if more about emotion than math. If individuals knew the math we would not have had the housing bust and $1.2 trillion in consumer debt.

            The question, then, is whether people who get cards for the perks reap an advantage. Fortunately, the Federal Reserve has massive resources with which they can do research on topics such as this.

            Late last year, the Federal Reserve Bank of Chicago came out with a report titled, “Why Do Banks Reward their Customers to Use their Credit Cards?” The report studied the effects on consumers who were given a credit card that rewarded them with cash back on their purchases.

            First, the good news. Individuals received $25 in cash back from the program. Unfortunately, this is where the good news ends.

            Individuals who participated in this program ended up in worse financial shape than before receiving the card. With the new cash back rewards cards, individuals on average spent $68 more a month on their credit cards than before receiving the card. With this increased spending there also was less money to pay off the credit card bill at the end of the month. This resulted in an average increase of $115 a month that was added on to the individual’s credit card debt.

            Why do credit card companies offer credit cards with perks? They know they pay off … for the credit card companies. When someone receives a credit card that gives him or her cash back, the credit card company knows that individual is likely to spend more and have a higher balance on the card. This will mean more interest payments and possible late payments going to the credit card company.

            Can you get a credit card with perks and reap the benefits? Yes you can, and if you can reap the benefits without the dangers, go for it. If you are like most, the extra cost will outweigh the benefits.

            Most financial decisions involve a balance between reward and risk. When one invests in a diversified stock portfolio there is chance the individual will lose money, but odds are over time there will be a decent return — around 10 percent — on the investment. When one takes money to a casino, there is a chance the person will leave with more money than he or she brought, but odds are the individual will leave with less money.

            With credit cards that offer perks, there is the same reward and risk situation. An individual has the chance to earn more in perks than the cost of owning the card. However, odds tell us that when these cards are issued, individuals fall deeper in debt with higher interest payments. Everyone has to make their own decisions based on the rewards and risks available. Personally, credit cards that offer perks is one risk I do not want to take.

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