Cash back credit cards: what's the catch?

Question

I had a 1% cash back credit card. It gave me $1 back for every $100 I spent. I don't believe in easy free lunch. What's the catch? What do I lose from these cash back programs?

I can't think of any advantages of cash back for the bank. I can only think of a disadvantage: abuse by cardholders. For example, if I'm buying a $1 soda, I could ask the cashier to charge $100 to my card and give me $99 back in cash. With $1 from the credit card's cash back, my soda effectively cost $0.

How do banks gain from cash back programs?

Answer 1

Banks generally charge retailers between 2% and 3% for processing credit cards charges, and the 1% cashback to you comes out of that. They still make money on the remaining 1% to 2%, assuming you’re a good credit risk. And cashback isn’t available on cash advances, so your plan to get cashback on a cash advance involves someone committing fraud — whether it’s you or the retailer depends on the exact details of the contracts and how your plan will work. But in any case, a retailer who is paying the bank $3 to process a $100 charge is unlikely to let you buy something for $1 and give you $99 in change — they would be out by $2 and a soda.

Answer 2

The catch is that they charge merchants more money to be able to use that card network at all.

There is nothing for the consumer to worry about. Yes, there are communities of people that try to game these systems for more advantages. Most cash back cards have limitations in the fine print on how much cash back they'll give, not your problem if they don't. The card companies can cut you off at their discretion as well. Typically your example won't work because the cashier would have to pay 3% to process the transaction.

Answer 3

There are two ways that they make their money:

• Vendor fees - they charge vendors 2-3% every time you use the card. Of course since credit is the biggest form of payment nowadays, this charge is just baked into their prices, so you're really paying it in the end
• Interest/late fees - if you find yourself in the unfortunate situation of not being able to pay the full balance in time, you'll pay monthly interest that will wipe out your "free cash" very quickly.

Plus, there are studies that show that people tend to spend more on discretionary spending with credit than they do with cash, so you're probably spending more than you're getting back by buying things you wouldn't have bought with cash.

Also, "cash back" is generally not subject to the rewards, so your $100 soda idea most likely won't fly.