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Are You Paying for Someone Else's Credit Card Rewards?

The Motley Fool logo The Motley Fool 1/16/2023 Lyle Daly
Girl holding credit card © Getty Images Girl holding credit card

Lots of people love using rewards credit cards, and it's easy to see why. There are cards that earn 3%, 4%, and sometimes even 5% or more back on purchases in certain categories. You also have your choice of earning cash back, airline miles, or flexible rewards points.

It's great for those who are earning big rewards, but who pays for them? After all, credit card companies can't whip up something of value out of thin air. It stands to reason that if someone is coming out ahead, someone else isn't.

Some have claimed that it's a reverse Robin Hood situation. Wealthy Americans are the ones who benefit, while poorer Americans who pay with cash or debit cards foot the bill in the form of higher prices. However, a recent study found that this isn't the case. Whether you benefit or lose money from credit card rewards depends primarily on your financial habits.

Who pays for credit card rewards?

A study released in Dec. 2022, "Who Pays For Your Rewards? Redistribution in the Credit Card Market," looked at how rewards redistribute wealth. It found that credit card rewards don't simply transfer wealth from poorer people to the rich.

It's actually consumers with higher credit scores who profit at the expense of consumers with lower credit scores. The study refers to these two groups as sophisticated consumers and naive consumers.

To understand why, we need to look at how card issuers fund their rewards programs. The largest U.S. banks paid $34.8 billion in credit card rewards in 2019. There are three types of fees used to pay for this:

  1. Credit card interest: Cardholders who carry a balance from month to month are charged credit card interest.
  2. Interchange fees: Merchants pay processing fees to accept credit cards. One of these processing fees, the interchange fee, is paid to the bank that issues the card.
  3. Card fees: Some credit cards have additional fees, with the most common being an annual fee.

Of those fees, interchange fees are the ones that contribute to higher prices. If a merchant makes a $100 sale, it may keep $97.50 or $98 after all the processing fees are taken out. Merchants raise prices to balance paying these fees. Cash and debit card users pay the same higher prices, without earning rewards. But there are a few clarifications to add here.

You don't need to be wealthy to get a rewards card. The best rewards credit cards do require good credit, but your income isn't a factor in your credit score. You can build a high credit score and qualify for rewards cards no matter your income and bank account balances.

There are also those two other fees to consider. In 2019, the largest U.S. banks made more than twice as much money from interest and card fees as they did from interchange fees. They reported income of:

  • $89.7 billion in credit card interest
  • $41.3 billion from interchange fees
  • $9.9 billion in card fee income

The rewards study compared rewards earned and fees paid by cardholders with different credit scores and incomes. It found that rewards cardholders with high FICO® Scores earned more in rewards than they paid in fees. Rewards cardholders with low FICO® Scores paid more in fees than they earned in rewards. This was due to suboptimal habits by the latter group, who carry higher balances and pay more interest.

It also clarifies that these results "are not driven by income, as they hold within the sub-samples of low-, middle-, and high-income individuals." What mattered were credit habits, not how much money consumers made.

How to profit from credit card rewards

It's easy to be part of that "sophisticated consumer" group that profits from credit card rewards. There are only a couple of things you need to do.

The most important is to always pay your credit card balance in full. By paying in full, you don't get charged interest. The value of rewards will never outweigh the cost of interest, so this is crucial.

In addition, avoid unnecessary card fees. Pay on time so you don't get charged a late fee. If you're considering a card with an annual fee, make sure it has enough benefits to make up for that. Credit cards with annual fees can provide much more value, but only if you can take advantage of their perks.

Credit card rewards are mostly paid for by consumers with lower credit scores who carry balances and incur more interest charges. To some extent, shoppers who use cash and debit cards also pay in the form of higher prices. The good news is that at any income, you can be one of the consumers who benefits. Get a rewards credit card, pay the bill in full every month, and you'll come out ahead.


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