Monday, December 7, 2015

The Myth of Rewards Cards

Faux Financial Sites will try to tell you that you can spend your way to wealth.  You can't.

Bank of America offers a "Rewards Card" which pays you 1% back on basic purchases, 2% on groceries and 3% on gasoline.   There is no annual fee, but the interest rate is about 14% (actual rate varies depending on your credit score).  As a "Platinum" customer, they are offering to upgrade these rewards by 75% and pay a $100 bonus if I sign up.

Is this a good deal, or just a financial trap?   I have been chastised in the past by the "steal the cheese" people who claim that these types of bargains are the way to financial success.   I disagree.

While you may make a little money on the side, you are risking a lot in the process, particularly if you are signing up for a very high interest rate card.

The "steal the cheese" people argue that you can just pay for everything in your life with the rewards card, and then get a lot of money back.   They suggest putting utility bills and other regular payments on the rewards card - and get 1% back!

The problem is, since companies have to pay a processing fee of 2-3% to the credit card company, many no longer allow you to pay their bills by credit card.  Or if they do, they charge a "convenience fee" that largely wipes out your "reward" if in fact it does not exceed it.   For example, if I pay my property taxes on the condo with a credit card, they charge a $69 convenience fee, while the "reward" is $127.63 with the "bonus" applied.   For some other cards or payments, the convenience fee may exceed the reward.

So how much can you make on a deal like this?  Maybe $500 or so, from what I can see.   If you charge $2000 a month on a "rewards" card and average a 2% reward for each transaction, you may end up with $480 at the end of the year.   Yes, this is money I would pick up from the sidewalk, but it is not a lot in the greater scheme of things.

Initially, it may seem like a great deal.   Your first "bonus" check is over $100, with the $100 signing bonus and the 75% rewards.   But then the next bonus check is only a paltry $28 and you're wondering why the fuck you'd bother with this sort of thing.

Why is the bank offering this?   Well, they want your business, to be sure.   But if they are paying 2% on each transaction, it largely negates anything they earn from their credit card business.   With overhead costs, they are losing money on the deal.

So why do banks offer these cards?  Are they "nice guys" who want to "help out the little man" by offering cash back?   Remember we are talking about Bank of America here, right?

Or are they hoping to trap you in perpetual intractable credit card debt, and hope if they give you enough rope, you will hang yourself, and then they can offer you a debt consolidation loan or a home equity loan, and then amortize this debt over 30 years.

The name of the game here is to TRAP you - to entice you with little tidbits and hope you step in the bear trap.  Because at 15% interest, if you don't pay off the balance of the card for even just one month, the interest will easily exceed whatever "rewards" you might get.

And they hope you do this and the snowball effect kicks in.   Say you get this card, and you start spending with it.  In the back of your mind, you are thinking, "I am making money with this card!" so you tend to spend more.  So what if you spend 10% more - you are getting 1% back, right?   Your mind works this way, so just get over it.  We are all weak.

Compounding this is the nature of credit cards.   We kid ourselves we have "30 days to pay" and fail to realize how much is due and when.   A couple of months go by and suddenly there is $3000 in charges on the card - and not enough money in the checking account to pay it all off.

So you make less than a full payment that month.   Interest charges on the entire balance kick in, from the date of charge.   This can add over $100 to your balance.   If you keep using the card, any payment you make is only on the newer charges (it "revolves") and not the older balance, which keeps rolling over and rolling over and interest keeps piling on.  Pretty soon, you've given up all hope of paying off the balance in one lump sum.   Pretty soon, you are down to making the minimum payment.   Pretty soon, you are in a world of woe.

Who does this happen to?   Idiots?   Slackers?  People with no financial discipline?   No, it happens to you and me.  It happened to me, chances are, it happened to you or will sometime in your life.   And it only has to happen once for the banks to make back all their "rewards" money and then some.

Again, 70% of people surveyed claim they pay off their balance every month.    However, according to the credit card industry, 70% of credit card holders carry a balance on any given month.   It is clear that we lie to others - and ourselves - about our dirty little secret credit card addiction problem.

So how do you avoid this trap?   Don't bite on the bait.   Sure, you might think you can "steal the cheese" by snatching it away before the jaws of death descend upon you.   Most mice think this.  Even after getting caught in the trap, mice go right back and try again and again, as the video below illustrates.

This mouse tries to steal the cheese (in this case, peanut butter) and ends up in the bucket.  It takes him an hour to jump out.  He goes right back and tries again - dozens of times!  This is akin to what most people do when it comes to credit card debt.   Finally, in the end, the mouse decides to leave this trap alone, as the tiny amount of peanut butter just ain't worth it!
Even if you have perfect financial discipline and remember to pay off the balance every month, 12 months a year, for the rest of your life, it only takes one mistake to unravel the whole thing.   And even if, somehow, you avoid making this one mistake, well, the "rewards" are pretty minimal.  1-2% of your credit card spending just isn't a lot of money, given the risks involved.

It is akin to carrying around a loaded pistol in your belt, aimed at your crotch, with a hair-trigger.   Sure, it might not go off, but if it does, there goes the family jewels!

Airline "miles" or Hotel "rewards" cards are even worse, in that they don't even give you money to spend.  They give you airline miles, which are very, very hard to redeem, in this day and age, where every airplane is full of paying customers.

The best bet - the safest bet - is a low-interest rate credit card.   If you don't pay off the balance on a 7.17% card, the most you will be nicked for is a few tens of dollars.   You can't get so far behind the 8-ball with a card like that that you can never realistically pay it off.

It is your choice, of course.   But for me, I think the "rewards" with rewards cards are not worth the risk.   And that is what real financial acumen is all about - balancing risk with reward.