For years, I thought the last free lunch in the world of personal finance was 401(k) matching dollars. But a recent look at the world of credit cards with rewards attached shows me I was mistaken.
Whether you want gasoline, hotel rooms, plane tickets or cold hard cash for using the plastic in your wallet, the stuff is out there. Banks are no dummies, explains Ben Woolsey, senior industry analyst with creditcards.com, a card rating Web site. They’ve realized that reward cardholders are much more loyal than traditional cardholders, hanging onto their specific pieces of plastic an average four or five years, compared to one to three years for a card without rewards. That’s a big deal in an era when the cost of acquiring a single consumer runs $50 to $200.
Consumers are taking notice, too. According to TNS Financial Services, a market information company, two-thirds of all cardholders today have at least one reward card, up from half just four years ago. But just as signing up for a 401(k) is only one step along the road to maximizing those matching dollars for retirement, strategy plays a hand in reward-card selection as well. First you have to get the right card. Then you have to make sure it pays off big. Here are the steps to follow:
Start with cash back. For the vast majority of credit cardholders, cash back cards are going to be the way to go. That’s because most people don’t charge enough each year to come anywhere close to an airline ticket or accumulate real dollars toward a car.
These days, the best ones offer 5 percent on daily purchases — like gasoline, groceries and drugstores — and 1 percent or more on everything else. The fact that many cash-back cards cap their rebates at $300 a year or 30,000 points isn’t a problem for the average consumer because most people don’t even come close to that.
If you’re a bigger spender or a bigger traveler, cast a wider net. If you spend more than $1,000 a month or travel frequently, particularly if you do so on the corporate dime, you may get a bigger bang for the buck with a co-branded airline program (like the United or American or Delta card) where you could use a 30,000-mile ticket for a flight that might ordinarily cost $1,000 or more. Using those same miles to purchase a couple of upgrades to first class is even more cost effective.
Co-branded airline cards often do have annual fees attached, notes Woolsey, but you can justify them if you figure out how to double dip by charging tickets on the airline (and then getting more miles for flying) or using one of the partner hotel or car rental programs. Plus, he says, “a lot of these programs give you 10,000 or 20,000 just for signing up.” If you prefer cash over miles, look for a cash-back card that doesn't cap your rewards — like the ones from Discover or American Express.
Specialized cards may be a good second play. If you spend a lot of money at a particular merchant (say Barnes and Noble or Banana Republic) or hotel (like Hilton), using their card in their shop can be tough to beat, says Curtis Arnold, founder of cardratings.com. But you’ll want to have a good general card, like Amex Blue Cash, that gives you a fat rebate back on other purchases. Arnold and his wife use Amex Blue Cash, for instance, to get 5 percent back on gasoline, groceries and drugstore purchases. But they use the Bank of America Power Rewards Visa for all other purchases because they get a flat 2 percent back — more than they’d get from Amex Blue.
Make sure to pick a reward you'll redeem. Experts note there’s a “huge breakage” rate in the reward-card industry — there are many points at which the process breaks down, and not in the consumer's favor. Consumers earn rewards but don’t bother to call to ask the card company (as they have to in many cases) to write them their rebate check. Then, once we get those rebate checks or gift certificates, we neglect to cash or redeem them. In some programs, 50 percent of rewards aren't redeemed, says Woolsey, who spent 20 years working inside the credit-card industry. If this sounds like you, pick a reward that will be automatically credited to your credit card or to a savings account in your name.
Watch the interest rate. The standard advice used to be: If you revolve or carry a balance from month to month you shouldn’t have a reward card. You should have a plain vanilla, low-interest rate credit card instead. In fact, that's not true anymore. Today, reward cards are being issued at a variety of rates — some of which are truly competitive at under 10 percent, says Arnold. If you occasionally revolve or carry a small balance and would like a reward card, go ahead and shop around for one with low interest and perks to boot.
But be sure to keep your spending in check. The one unfortunate side effect of reward cards is that they encourage spending. On average, says Woolsey, cardholders charge $7,500 to $10,000 per year on reward cards, nearly double the $3,000 to $5,000 that they charge on cards without perks. A credit card is a helpful tool that, when used wisely, can make your financial life much easier. But if you go overboard, it can also lead you down a path that’s all too difficult to reverse.
Jean Chatzky is an editor-at-large at Money magazine and serves as AOL's official Money Coach. She is the personal finance editor for NBC's "Today Show" and is also a columnist for Life magazine. She is the author of four books, including "Pay It Down! From Debt to Wealth on $10 a Day" (Portfolio, 2004). To find out more, visit her Web site, .