Cash-back cards may be costly in the long run

Credit card companies are hungry for new customers, so they’re flooding the mail with offers for rewards cards.

“It’s about acquisition. It’s about making your offer stand out,” says Andrew Davidson, vice president of the direct marketing consulting firm Mintel Comperemedia . “At the moment, consumers are very attracted to the best cash-back rate or getting the most rewards for the dollar.”

According to Mintel, during the third quarter of 2010 (the latest figures available) eight out of 10 credit card offers were for rewards cards. That’s up from six in 10 the year before. And the emphasis has shifted to cash rewards. Based on the latest data, 41 percent of the direct mail offers for rewards cards are for cash-back cards. It was only 28 percent in 2009.

“Cash-back has become sort of the ideal recession product in terms of credit cards, because you’re getting something back for something you already spent your money on anyway,” Davidson says.

Cash-back cards also tend to foster loyalty. Most people have multiple credit cards. Bankers want their card to be the one that gets used. That’s why some now offer a bonus if you sign up for their card and start charging right away. For example, with the Chase Freedom Visa you get an extra $100 reward after you spend $500 in the first six months.

These cash-back offers aren’t going out to everyone. They’re generally limited to the most creditworthy individuals. After being burned by the recession, credit card issuers want customers who will use the card a lot and pay their bills on time.

“Every time the consumer swipes the cards, the card issuer gets some money,” notes Greg McBride, senior financial analyst at “And with consumers who pay that balance in full each month, there’s very little risk of default.”

So do cash-back cards encourage more spending? Economists at the Federal Reserve Bank of Chicago wanted to find out. They looked at 12,000 random credit card accounts provided by a large U.S. bank, which was not identified. During a two-year period half of the customers had been offered a 1 percent cash-back reward, the other half had not.

Those who used the cash-back card got an average reward of $25 a month but spent an additional $68 per month, according to the study. And the balance on that card went up $115 a month.

For customers who had not used their card for three months prior to the cash-back offer, 11 percent spent at least $50 in the following three months.

“Not only did they increase their spending, but they increased the debt on this specific card,” says study co-author Sujit Chakravorti, who tells me he was surprised by the results. “A very small financial incentive gets you to make a big change in your payment habits.”

(Read: by Sumit Agarwal, Sujit Chakravorti and Anna Lunn)

“What it tells me is, this is a very effective way to get your card to the top of the wallet,” Chakravorti says.

Rewards cards have lots of rules To be successful at the credit card reward game, you need to read all the terms and conditions as you compare offers.

“There are a lot of loopholes with these cash-back cards,” says Bill Hardekopf, CEO of . "A lot of these cards have limitations on the amount of money you can get back."

For example: With the Chase Freedom Card you cannot earn more than $75 per quarter in rewards, no matter how much you spend.

The Citi Platinum Select card tops out at $300 per year. The Discover More card pays 5 percent on travel and restaurant purchases made from January through March of this year, but only up to $800.

“It’s fairly easy for people to start spending more when they don’t know what the cutoff is,” warns Beverly Blair Harzog, who reviews credit card offers for . “You keep making purchases thinking you’re getting all this money back, and you’re not.”

Be aware of rotating categories. That 5 percent rebate may be limited to a single type of purchase each quarter, such as food, clothing, gasoline, travel or entertainment. The rest of the year, you might only earn the basic 1 percent. And you might have to go online and sign up for that quarterly special.

A few more things to remember:

  • You may have to spend a certain amount before the cash-back reward kicks in.
  • Some cards do not include purchases made at warehouse stores toward a spending level for a higher rebate.
  • That cash bonus you earned but have not collected can be wiped out if the account is closed or if you make a late payment two billing periods in a row.
  • Credit card rewards programs, just like those run by the airlines and hotels, are subject to change at any time. So it’s important to read everything that comes in the mail.

“You can get some great cash-back rewards,” Blair Harzog says. “But you really have to stay on top of all the information and empower yourself with knowledge if you really want this to work for you.”

ConsumerMan caution Rebate cards have significantly higher interest rates than the average credit card. You should not even consider a rewards card unless you pay off the balance in full every month and can resist the temptation to overspend. If you carry a balance – even occasionally – that higher interest will more than wipe out any cash-back bonus.  In that case, you need to find a card with a rock-bottom interest rate.