Credit Card Rewards: A Financial Boon or a Debt Trap?

Credit card rewards programs can be both a blessing and a curse, depending on how they are managed. While some consumers can reap significant benefits from these programs, others may find themselves falling into a debt trap. In this article, we will explore the various advantages and disadvantages of credit card rewards programs, incorporating the perspectives of both proponents and critics, including Dave Ramsey from a few articles (like this one or this one.)

Table of Contents

1. Benefits of Credit Card Rewards Programs:

Ability to enjoy rewards from free flights, hotel nights and more

For disciplined consumers who pay off their credit card balances in full every month, rewards programs can be a financial boon. By making regular purchases and avoiding interest charges, these consumers can take advantage of cashback, travel miles, or points, effectively saving money on purchases they would have made regardless.

The emphasis here is disciplined. That’s right, disciplined. As in, ‘I will not buy that 5th inflatable pool flamingo because I don’t NEED it, Karen!'”

And you (and your family members) need to look at your actual budget and actual spending record to know whether you are a disciplined consumer or not.

Incentives for large purchases

Credit card rewards can provide substantial benefits for consumers making large purchases or planning expensive trips. With certain cards offering travel insurance, purchase protection, and other valuable perks, consumers may find using a rewards card a smart financial move. For example, you can read more about American express platinum travel insurance here.

Building credit history

Using credit cards responsibly and paying off the balance in full every month can help consumers establish a good credit history. A positive credit history can lead to better terms on loans, lower interest rates, and increased financial opportunities/options in the future. Here Dave Ramsey and his team may argue that you don’t need a credit score in the first place if you don’t intend to go into debt and the fact that credit score is a very recent “invention.”

I disagree with them because as expat who recently moved to the US, I didn’t have any credit history /credit score, and I’ve experienced so much hassle from signing up for simple mobile plans to renting an apartment. So not building your credit history is not a feasible advice for expats, who recently relocated to the US.

2. Drawbacks of Credit Card Rewards Programs:

The hidden costs

Although credit card rewards can be enticing, it’s essential to consider who is ultimately paying for these perks. Credit card companies generate revenue through fees paid by cardholders, transaction fees paid by businesses, and interest paid by cardholders who carry a balance.

On average,  the processing/transaction fee is typically between 1.5% to 3.5%, charged by the credit card companies to merchants. The merchants often pass that fee to consumers by increasing the price of their product/service or charge a credit card convenience fee. So basically, it is us, consumers who fund these credit cards points.

Encouraging overspending

Credit card rewards programs can sometimes encourage consumers to spend more than they otherwise would. The allure of earning points or cash back can lead to unnecessary purchases, ultimately negating the benefits of the rewards program.

Remember, the cashback rate, or points or miles (or equivalent) is often lower than 3%. So the math is quite simple. If you don’t spend, you save 100%. If you spend, you may save 3% (or less). It’s like saying, ‘Sure, you could save 100% of your money by not buying this diamond-encrusted hamster wheel. But wouldn’t you rather save 3%?'”

Perpetuating debt

Credit card rewards programs can create a cycle of debt for some consumers, particularly those who are unable to pay off their balances in full each month. With high interest rates (often more than 18%/year) and the temptation to spend more to earn rewards, these consumers may find themselves in a downward spiral of debt.

According to the New York Fed, in Q4 2022, American households had credit card balance of $986 billions. (Yes it is the letter B). “The increase in credit card balances between December of 2021 and December of 2022 was $130 billion, also the largest annual growth in balances.” You can read more from this article “Younger Borrowers Are Struggling with Credit Card and Auto Loan Payments” from NY Fed.

Debt’s like a hole that just keeps getting deeper the more you dig. Except instead of finding treasure at the bottom, you find a note that says, ‘Congratulations! You’re broke.'”

The complexity of some rewards programs:

Some (certainly not all) credit card rewards programs come with complex terms and conditions, making it difficult for consumers to fully understand and maximize their benefits. In some cases, rewards may expire, be subject to blackout dates, or have other restrictions that limit their usefulness.

3. Perspective of someone who is not from the US

As someone who recently relocated to the US from Asia, I can say the following things:

  • Credit card or digital payment, in general, is just a tool. It is not good or bad, just like any other tools.
    • Nuclear energy can be used as a green energy source, and a nuclear bomb is a weapon of mass destruction.
  • The US is actually behind many countries when it comes to digital payment. After 18 months, our family still gets surprised about the usage of cash, of physical checks and the like in the US. In many countries.
  • There are many other payment options in Asian countries outside of Visa/Master or American Express. Indeed, the processing/transaction fee of 1.5% – 3% is too high, especially for small businesses.
    • In Singapore, Nets is free to use. Yes 0%
    • In China, WeChat Pay or Alipay charges substantially less (like 10 times less or more).
    • American Express is not widely accepted in many countries in Asia like Singapore, South East Asia, South Korea, Australia, China, etc… because the transaction fee is too high. They are not competitive.
  • However, it is not straightforward or right to “blame” credit card companies and the rewards for outstanding consumer loan in the US. People use credit cards and receive rewards in other countries too.

4. Conclusion

Credit card rewards programs can provide valuable benefits to disciplined consumers who manage their spending and pay off their monthly balances. However, it’s also true that you need to be a disciplined consumer to use this tool well.

So be smart, folks. Evaluate your financial habits before you start chasing those shiny points. Because the only thing worse than no vacation is a vacation you can’t afford. Trust me, the ‘free’cocktail tastes a lot less sweet when it’s garnished with financial regret.

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