Credit card companies are in the business of making money, yet they often advertise incentives that feature rewards such as cash back on credit card purchases. Many consumers are inundated with online offers and mailers, promising great incentives, from zero to low introductory interest rates to one-time bonus rewards offers, to cash back deals whenever they use their cards. 

Nowadays, it isn’t unusual to see banks offer what seem to be very generous cash back incentives to their cardholders, even after the introductory bonus period is over. For example, Chase offers up to 5% cash back on its Chase Freedom Rewards Card, as does the Discover Card. So how can these companies offer such seemingly lucrative deals for consumers and still make a profit?

Cash Rewards Programs: The Fine Print

First, it is important to read the fine print. Most cash rewards programs have an annual maximum limit, so while they may offer a generous 5% cash back reward, there may be an annual cap or maximum limit you can reach. Other cards only offer cash back for certain categories of purchases, such as at restaurants or gas stations.

Discover’s cash back card is one of those that boasts a 5% reward on purchases. But, as of 2018, the cardholder agreement states that this offer only extends to specific categories allotted to different quarters of the year. And it comes with a limit of $1,500 in purchases per quarter. The disclosure also states that using a credit card with NFC technology or from a virtual wallet such as Google Wallet may not count toward the program.

Similarly, the Chase Freedom card also has spending restrictions and caps. Cardholders can earn 5% cash back rewards on spending in certain categories. Chase caps the spending limit each quarter at $1,500, just like Discover. Any other purchases during each quarter, and above the limit, earn 1%. 

With a credit card program with a $1,500 cash back limit per year at 5%, any spending over $30,000 would not contribute to accumulating any further cash back rewards.

Because most consumers do not take the time to read the fine print, they may open a credit card account under the impression that cash back rewards programs are much more generous and universal than they actually are.

It’s Not Free Cash

When merchants accept payment via credit card, they are required to pay a percentage of the transaction amount as a fee to the credit card company. If the cardholder has a participating cash back rewards program, the credit card issuer simply shares some of the merchant fees with the consumer. The goal is to incentivize people to use their credit cards when making payments rather than cash or debit cards, which earns them no rewards. The more a consumer uses a credit card, the more merchant fees the credit card company can earn.

Additionally, credit card companies make money by charging high interest rates on balances that carry over month-to-month, and issuing late fees for payments missed or made after the stated due date. The more consumers use their credit cards, the more likely it becomes that they will miss a payment or carry a balance for which they will owe fees and interest.

According to the Federal Reserve, the average credit card interest rate is 16.61% as of Q1 2020. The Federal Reserve also reported almost $1.07 trillion in outstanding revolving credit by March 2020. Approximately 43% of credit cardholders carry a balance from month to month according to the latest Federal Reserve Survey of Consumer Finances. 

Credit cards that offer the most generous sounding rewards programs also often carry the highest fees and interest rates, compared to a similar card with a lower rewards program, or none at all. 

The Bottom Line

Cash back rewards sound enticing, and they can help certain consumers save a bit on credit card purchases. However, once the restrictions and qualifications are spelled out in the fine print, including any limitations on how much cash back credit card users can earn per year, these programs do not appear as generous as they may seem on the surface.

Because these programs are incentives for consumers to use their credit cards in lieu of cash or debit cards, they generate increased merchant fees for the credit card company and may also cause some consumers to increase their debt, providing yet another source of revenue for the credit card company. According to Visa USA, the average transaction amount is 4X more with a credit card vs. cash and nearly twice as much vs. a debit card, greatly adding to the revenue coming from merchant fees. And since cash back credit cards carry the subtle psychological incentive of earning money while you spend, people tend to spend even more on them than non-rewards cards. So, rather than draining corporate profits, cash back rewards programs actually dramatically increase credit card companies’ bottom lines.