Credit card rewards can feel super fun. Buying new things and spending money is exciting, and if you get gifts for doing so, what’s not to love? Credit card companies are well aware of consumer appeal – rewards are a good way to get them people at the door And Try to keep them loyal.
What many consumers don’t like to think about are the trade-offs they make when signing up for rewards cards; After all, your points, miles, and cashback aren’t gifts from heaven for being special. Bonuses can come at a hidden cost, Mostly for low income consumers and people who pay cash Yet merchants, who pay higher withdrawal fees for fancier cards, pass on additional expenses. But rewards cards also come at a cost to people who, frankly, aren’t very good at using them. With all the websites dedicated to ways to play the credit card system game, it’s easy to overlook all the ways that, if you’re not careful, the system is playing you.
Rewards cards are only really useful for consumers who are generally credit savvy. Consumers who are less financially savvy—meaning people with higher unpaid balances or who don’t pay off their cards from month to month—ultimately end up losing out. They end up subsidizing the rewards of people who are slightly better in credit, wherever they fall on the income spectrum. More than half Many credit card customers are “revolvers,” meaning they don’t pay off their balances in full each month.
said Andrea Presbytero, chief economist in the IMF’s research department and one of my co-authors 2022 sheets Consider rewards and redistribution in the credit market. “Simple people, gullible people, make a lot of money mistakes.”
Prompt: For banks, it doesn’t really matter whether or not a rewards customer is particularly good at managing their personal finances. They make money either way. Let’s analyze what Prespitero and his colleagues found.
If you can’t pay off your balance, you might pay for rewards for someone who can
Rewards cards are a booming business for issuers and are popular with consumers across the credit spectrum. according to Consumer Credit Card Market Report 2021 from the Consumer Financial Protection BureauEven people with “deep subprime scores” — meaning very low credit ratings — put more than 60 percent of their credit card purchase volume on rewards cards, and nearly three-quarters of semi-prime consumers did the same. Consumers with higher credit are the biggest reward spenders. (If you need a full explanation of the US credit score system, You can find one here.)
How much, if any, bang people get for their money really changes across the credit spectrum, according to research by Prespitero and colleagues. They found that people with excellent credit (those with a FICO score of 780-850, upper end) earn an average of $9.50 in rewards and pay $7.10 less in interest each month on rewards cards than on the classic run-of-the-mill card mill. . Mortgage consumers, that is, people with credit scores below 660, earn just $1.80 in rewards and pay an additional $6.40 in interest. “We estimate a total annual redistribution of $15 billion from the least educated to the most educated, the poorest to the richest, and from the highest to the lowest for minorities, widening existing disparities,” their report reads.
The researchers looked at two specific areas in which what they call “naive” consumers make more mistakes with rewards cards: They borrow too much, and they don’t pay their credit card debt optimally. Focus on rewards cards that offer points, miles, or cash back for dollars spent; The data did not include benefits such as access to the airport lounge.
On the first front, they looked at bank-initiated credit limit increases on rewards cards, which means cases where the bank says something like, “Hey, here’s an extra $1,000 on your credit limit, don’t worry.” They found that these increases led to higher unpaid balances among consumers with lower credit scores — they increased their spending because they could, but they could not increase their ability to repay that debt.
“If you’re a simple guy, you get an extra $1,000, and you increase your consumption and spending, but you are unable to increase your payments because you’re tied up,” Prispeptero said. “You end up with unpaid balances, and on those balances, you’re going to pay interest rates and fees. So yeah, maybe you’ll get like $2 in bonuses, but then you have to pay $5 in interest.”
On the second front, the researchers examined people who had multiple cards at the same bank and looked at how consumers handled their various debts. They found that consumers with low credit “tend to have an imperfect (and expensive) balance matching technique when paying off their credit cards, which means they don’t pay off their cards in the best way possible. For example, they focus too much on cards with higher balances and not cards with higher interest rates, Where debt will eventually be more expensive.
The problem isn’t necessarily that some consumers don’t know the best way to pay down debt and handle their rewards cards, Prispeptero said, it could just be that it doesn’t really matter to them, or that they’re not paying attention. . “They may be so rich that they don’t care,” he said. “You could be unsophisticated and not know, or it could simply be due to what economists call rational inattention; it makes sense not to pay attention.”
Whatever the case, when people mess up rewards cards, they pay the price — and that price ultimately helps pay the rewards for people who don’t.
On a macro level, this has a geographic impact. Presbytero and colleagues note that on the network, average rewards are higher in ZIP codes with higher education levels, higher median incomes, and a lower proportion of the black population.
The bank wins regardless
It can be uncomfortable to think about where credit card rewards come from. Yes, it’s nice when you get it, but it’s not really inevitable or necessary. It’s a little embarrassing that consumers are offered a prize for the act of engaging in capitalism, and a prize where there are fairly large trade-offs, on the net, between consumers and merchants and other stakeholders.
The important thing to keep in mind here is that credit card companies and banks are in the business of making money, and they won’t hand out rewards cards if there’s nothing in them. In this case, there are billions of dollars at stake.
Issuers make money on rewards card holders regardless, across the credit spectrum. The researchers found that banks benefit most from semi-primary consumers and primary consumers in the middle of the FICO score distribution. At the high end and the low end of the FICO scale, the ways banks make money are different. For inconvenient consumers, more than 60 percent of banks’ revenue on rewards cards comes from interest income. For high-end consumers, more than 80 percent of income comes from exchanges, which means pass-through fees that merchants pay when people spend them. In the middle, banks can make money on interest charges And Swipe fee.
“It’s clear that the bank is the winning player here,” Prispeptero said. “No matter how I behave, if I am a gun or not, if I spend less or more, the bank always makes money.”