How Do Cash Back Credit Cards Work?
It’s tough to say “no” to rewards on your spending. You can see it as getting something free for a purchase that you’re going to make anyway. But, rewards can come in many forms -- points, miles, cash back, and more. To some people, cash back is the best of the bunch. Why? It is the most versatile reward because you can choose how you wish to use it.
Quick answer: Whenever you make a purchase, you earn a percentage in cash back. Accumulate the cash back and redeem it for a direct deposit, paper check, or statement credit.
This is part of the reason that cash back credit cards are such a popular credit card category. We provide the best cash back credit cards worth considering, how they work, and what you can do to earn the most cash back.
Best Cash Back Credit Cards
Fidelity® Rewards Visa Signature® Card
For an all-purpose, all-around cash back credit card that maximizes your rewards on every purchase you make, you can’t go wrong with Fidelity’s Visa Signature Card. It offers a 2% cash back rate everywhere you shop, regardless of spending category.
The cash back must be redeemed in a Fidelity account: your choice of a brokerage account, IRA, 529 College Savings Plan, or a cash management account. The cash management account is very much like a checking account. You can use that account to withdraw the cash back without using it for investments.
Citi® Double Cash Card
The Citi® Double Cash Card is rather unique compared to other cash back credit cards. Not only do you earn 1% cash on what you spend, but you get another 1 percent back when you pay off your balance.
Effectively, you can earn 2% cash back. There are no spending categories with limits and no annual fees. It is a great card for people who don’t have any major spending categories.
Note: In order to earn the 2% cash back, you are advised against redeeming cash back as statement credit. A statement credit will reduce the balance that you owe on the card. Therefore, you won’t have to pay that portion of the balance, which means no cash back earned.
Blue Cash Preferred Card from American Express
Grocery shoppers will find their best match with the Blue Cash Preferred® Credit Card from American Express Card. Its highlight feature is the 6% cash back rewards on up to $6,000 spent (annually) on supermarket purchases. Also, you can earn 3% cash back at gas stations and department store and 1 percent on all other purchases.
Other benefits to the card include an 0 percent introductory APR on purchases and balance transfers for the first 12 months. Cash back is issued as a statement credit.
The Discover it® card has a cash back program that awards 5% cash back on certain categories that change every 3 months (up to the first $1,500 spent in these categories during a quarter). These categories are often season-appropriate and include gas stations, dining, movies, home improvement stores, department stores, and more. All other purchases earn unlimited 1% cash back.
As we always advocate improving your credit and staying current with your credit score, a free, always updated FICO score is also available through the Discover it® card. There are also zero foreign transaction fees for frequent travelers.
What is Cash Back?
Cash back can be seen as a type of rewards currency. When you’ve saved up enough cash back, you redeem it as actual cash (or something equivalent to it).
Redemption options of include:
- Direct deposit into a bank account
- Mailed paper check
- Statement credit
You can choose whichever redemption options is best for you. Credit cards companies may require you to save up a minimum amount of cash back before you can redeem it.
One common concern is the tax burden of earning cash back. Because cash back is the result of buying something, it is seen as a rebate. It is not an upfront bonus for doing nothing. Therefore, you don’t have worry about taxes.
How to Earn Cash Back
With most cash back credit cards, you’ll earn cash back on nearly everything you buy. However, your card may have a program that pays more cash back on certain spending categories.
Note: Unless there is a special promotion, you don’t normally earn cash back on balance transfers and cash advances.Some consumers may carry different cash back credit cards for different kinds of spending in order to earn the most cash back.
Many credit card issuers have online shopping portals that let you earn even more cash back. Basically, you must go through these portals before landing on the website of an online store. When you complete an order, you’ll earn a certain amount of extra cash back. This cash back does stack on top of the cash back that you’d earn regularly as part of your card.
Hack Your Way to More Cash Rewards
Every location that accepts your credit card will have a merchant category. This merchant category must match the cash back category set forth by the credit card company. If they don’t match, you won’t earn the cash back.
When it comes to cash back with credit cards, it only matters where you make the purchase. The good and services that you bought will not matter.
For example, you have a credit card that pays 6% cash back at supermarkets. Whatever is sold at the supermarket will be eligible for 6% cash back. Because supermarkets often sell branded gift cards, you can buy them and earn high amounts of cash back.
There are three ways you can identify the merchant category of a location:
- Ask someone that works there. Usually, a store manager or cashier will know the store’s merchant category.
- Make a test purchase. Buy a small item and you can check your transaction history to see the category of the purchase.
- Use the online Visa supplier locator tool. This free online database lets you look up the merchant category of all locations that accept Visa. These categories are likely to be the same for MasterCard, Discover, and American Express cards.
Tradeoffs for Cash Back Programs
Credit card companies need to make a profit and support their bottom lines, after all, so it pays to know just how cash back cards really work, and if you’re getting the most out of your money by signing up for one.
Watch for Fees
Though it may seem like free currency, cash back rewards do come at a price.
Credit card companies earn a great deal of their money through merchant fees and cardholder fees. Merchant fees are also known as interchange fees. It is a cost paid by a retailer or merchant to accept credit card transactions. Merchant fees may average between 2 percent to 4 percent per transaction. They may vary according to the type of merchant and transaction, location, and card provider. (For example, Discover and American Express conventionally carry higher fees than Visa or MasterCard.)
Essentially, it’s these fees earned by card providers that they share with their card holders in the form of cash back. It’s a give-and-take process: by offering consumers cash back on their purchases, cardholders are poised to spend more on their card (instead of using cash), so the card company earns its merchant fees, and then gives back a portion to their customers.
So, when a bank like Citi earns a substantial amount of money from merchant fees, for one, it can translate that back into rewards for the consumer, especially when a unique cash back program -- like the Double Cash card -- is offered.
Many cash back credit cards may start with a $0 annual fee for a limited period of time.
In addition, account holders may be subject to balance transfer fees for importing funds from one card to another, and penalty fees if payments aren’t on time -- more big revenue streams for card companies.
Of course, then there’s the big money maker for card companies: interest rates. All credit cards derive income from the interest rates they charge to consumers. For credit cards that offer rewards, such as cash back, expect higher APRs.
Should You Get a Cash Back Credit Card?
Before applying for a cash back card, consider these questions:
- What’s the interest rate? If you tend to carry a balance from month to month, a 0 percent intro APR may be a nice perk, but those double-digit interest rates can counteract any cash back rewards you might receive.
- How are the cash back rewards organized? You’d be remiss to open a new card that doesn’t emphasize your spending habits. If general spending is how you like to use credit, go for the Citi® Double Cash Card or Chase Freedom® cards for more versatility. But if a large portion of your monthly spending is on groceries, a card like the Blue Cash Preferred would suit you better.
- How is the cash paid out? Not all cards give back cold, hard currency. Fidelity’s Visa Signature card is ideal for the budding investor who wants their cash back to benefit from compounding interest. Likewise, it’s not wise to redeem your cash on the Citi® Double Cash Card card as a statement credit because it could reduce the value of your earnings.
- What are the fees? Some cards carry zero annual fees. Others offer the same deal for the first year, and others still charge a fee from the start. You want to make sure that you're able to earn enough cash back to cover the fees
Ultimately, cash back credit card is a good choice if you like cash rewards and you don't carry a balance. If you carry a balance, the interest charges will exceed the value of the cash back. At that point, we would suggest a low-interest credit card instead.