Tuesday, October 4, 2016

Are Rewards Cards Worth It?

"They throw pennies at us, hoping we spend dollars"

A few years ago, I started this blog at the height of the recession, as it seemed the economy and my personal economy were coming unraveled.   I survived the meltdown of 2008 because I had largely exited the Real Estate market by then, and thus had a nest egg for retirement.   But I still had a bit of mortgage debt as well as credit card and even some student loan debt.   And when my accountant unexpectedly came down with brain cancer, I found I had a huge capital gains tax to pay to the State of Georgia - that was due in a matter of days.

Foolishly, I put the debt on a credit card.   That was bad enough.  But when I went on vacation, I sent my payment a day late, which back then would trigger "penalty" interest rates of 15% or more (sometimes as high as 20-25%) which meant that I had little or no hope of ever paying off that debt, as even a large payment of $1000 on the card went mostly to interest.

Once again, I had stumbled into a credit card debt crises - as most Americans do.

I say "once again" because I had done it once before, and you'd think I would have learned from the first time.

When I was in my 30's, we had credit cards - with account limits in the tens of thousands of dollars.   To a young man, this seemed like success, as after all, my Dad loved to flash his wallet full of credit cards as a sign of "success" in life.

Most of these cards had high interest rates and crappy "rewards" programs, such as frequent flyer miles, which are nearly impossible to use, unless you fly a LOT and use them to try to upgrade to business class.   The days of getting miles and flying the family to Hawaii are long gone.  And with lower fares, you'd be better off just shopping for a low-cost fare than trying to get a "free" flight by spending tens of thousands of dollars with a credit card.

Many of these cards also had annual fees.   I wasn't very astute about credit cards back then, as I was still in the mindset that I was "lucky" to get credit and when the bank sent a letter saying "congratulations! you qualify for a new Zinc card!" I was really naive enough to think that I was going somewhere.

But that somewhere was a financial hole.  We quickly ran up credit card debt by spending more than we made.  Not on big things, but on lots of little things.  Restaurant meals, delivery pizza, car parts for hobby cars, vacations, and whatnot.   We shopped back then for what we wanted and never bothered to think about prices of things, provided they were below that tantalizing "I'll just put that on the credit card" range of $99 to $499.

It wasn't long before we were no longer paying off the balance every month.  And within a couple of years, we were struggling to make the minimum payments on all the cards.   Bear in mind we had a combined income of well over $100,000 a year, and this was back in the 1990's when a hundred grand was a lot of money.

So I did what a lot of Americans did - refinance my house to pay off the debt.   It seemed the bank was throwing me a life-line, but in retrospect it was a life-line weighted with lead.   Once all that short-term high-interest debt was refinanced (of course, this after doing at least one or two "balance transfers") we congratulated ourselves on our financial acumen and ran up more credit card debt.

Wash.  Rinse.  Repeat.

And my experience is not unique.   A lot of Americans fall into this trap - a lot of middle-class Americans who have good educations and should know better.  The poor fall into worse traps - title pawn loans and payday advance places which take what little they have much more quickly.   A full-blown middle-class credit card crises can play out over a decade or more as the debtor refinances debts over and over again, not realizing their financial ship is taking on water.

The problem with credit cards is that they make it so easy to spend.   You buy stuff and swipe the card and don't think about the real money coming out of your account.   It is only when you get that huge credit card bill at the end of the month that you realize you've overspent.   And by then, it may be too late - you can't pay the full balance this month, so you let it ride and pay that high interest.

Compounding this was that I was self-employed and most of my clients were very irregular in paying - which is typical.   I could wait 30, 60, or even 90 days to get paid, particularly from overseas clients.  So often I had to use credit cards to pay Patent fees, or even to buy groceries, while waiting for payment from clients.

Foolishly, I had little in cash reserves to cover myself during these times of famine.

I decided to chuck high-interest "rewards" cards and other crappy deals in favor of simple, low-interest credit cards.   And I cut way back on spending.   We got rid of all our debts by selling off the vacation home, the hobby cars, the boats, etc. and learning to live on less.   We also found this was a better way to live as having too much stuff was physically exhausting.   Yes, it was fun for a decade or so, but by the time you turn 50, having to take care of "things" gets to be old.   And the older you get the less "things" you want to take care of.  Just keeping a house clean gets to be a chore after a while.

And it worked.   I started tracking all our expenses and kept things within our budget.   But of course, over time, the temptation is to spend more and more - and our banker friends know this.  In fact, they can track our habits pretty accurately from our spending.

And increasingly, the banks want us to use them for "one-stop shopping" for everything from investing, banking, credit cards, loans, and mortgages.   And to do this, they offer incentives if you are willing to move your money and business to their bank.

I prefer to have multiple accounts for savings, investment, credit cards, and banking, as it provides a back-up and flexibility for me.   If I don't like Bank A, I can just do more business with Bank B, where I also have an account.  If a credit card is compromised while traveling (yes, again, this time to Mr. See), I can simply switch to another credit card from another bank.   In fact, if you travel overseas with just one credit card, you may be asking for trouble.   Keep one card with you and another in your luggage or the safe at the hotel or with your spouse or wherever.   If one card is lost or stolen, you have options.

A reader wrote to me many months (years?) ago arguing that I was wrong to suggest using a low-interest simple credit card with a low balance limit.   He said that I could "steal the cheese" by getting a "cash-back" rewards card and then simply pay off the balance every month.    You could put all sorts of expenses on it - like your utilities, or indeed my Patent fees. It sounds nice in theory, but in practice, it is a dangerous high-wire act for many.   If you don't have a large balance in savings or your checking account to pay this balance every month, the "rewards" are quickly wiped out by the monthly interest expense.   Compound interest a bitch - when you're paying it.   It's a lot nicer to earn it.

And in the past I tried one such card - the sucky Discover card which no one takes anymore.   They offered a paltry 1% cash-back or so, which accumulated in your account until you had $50 in rewards and even then you had to ask them to pay it to you by check or apply it to your credit card balance.    $50 payable to an account balance in the thousands really doesn't make much of a dent.

Recently, Bank of America has been making a play to get more of my business.  They want more assets under their management as it makes their bottom line look good.  So if you transfer a couple hundred grand into a "Merrill Edge" account, you qualify as a "Platinum" customer, which doesn't mean much in terms of service (indeed, they closed my account while I was out of the country - so much for "platinum" service!) but does provide some "rewards" features, such as enhanced interest on savings (not much) and a cash-back rewards card that provides up to 3% cash-back depending on the purchase type.   And the cash-back is then amplified by 25% if you are a "platinum" customer.   They even have a calculator you can use here.   So if you spend $1000 on anything, you get $12.50 back.  If you spend it on groceries, you get $25 back.  If you spend it on gas, you get $37.50 back.

In addition to this are promotions that provide 10% back or so on hotel stays or hair cuts or starbucks coffee through Bank of America"AmeriDeals" which I discussed earlier.   These are OK if you plan on going to Autozone anyway to buy a new set of windshield wipers or staying at the Hampton Inn overnight.   But if you really want to "save" more than 10%, you could buy the wipers online (or at Wal-Mart) and stay in a cheaper hotel.   There is no real "savings" in these deals, only incentives to consume.

So, is any of this worthwhile?  Can you steal the cheese and come out ahead?   Yes and no.   And I decided to try, as an experiment, this rewards card and report back after a year and see what the results were.   Over a year, we were "rewarded" in both cash-back and "Amerideals" a total of $1544.62.   Each month Bank of America would deposit this money into my savings account and I tracked it on Quickbooks.  The best month was $268.30 while the worst was a mere $23.78. 

The average was about $128 a month, but this average was skewed by a $100 sign-up bonus the first month.   It helped that our $1098 a month Obamacare plan is charged to this card, as are our water and sewer bill and some Patent fees as well (which will go away once I retire).    Sadly, Georgia Power is no chump and will not allow you to pay your utilities with a credit card, unless you are willing to pay an extra fee for the service - which negates any real rewards savings.

At first, it may seem that we are coming out ahead in this deal.  After all, over $1500 a year!  That's real money!   And $128 a month certainly buys a nice dinner out, right?

Well, bear in mind that if we assume the average "reward" was about 2%, this means we charged well over $5000 a month on this card which is a pretty staggering about of money to spend in order to get a hundred bucks back.

In other words, they throw pennies at us, hoping we spend dollars.    And spend we did.   I think the use of this card encouraged spending - or at least it did this summer.   Yes, all that lobster was good, thank you.  But it wasn't cheap.  Even those little run-down shanties by the side of the road in Maine will charge $50 for two lobster rolls and some onion rings.

The system "worked" for us as we are spending money we have in the bank - and thus can pay the total bill every month.   But if we miss a payment for even one month - or fail to pay the full amount due by even a dollar - we will ring up far, far more in interest (at 15% or so) in one month than we would have made in "rewards".

The other problem with this card is that it has a whopping 3% foreign exchange fee.   While in Canada, I called Bank of America and a "platinum service adviser" told me he would refund these fees later on (he promised!) by manually entering a refund.   I found it simpler to use my low-interest Capital One card, which charges no foreign transaction fees, instead.   If you use the "rewards" card in Canada, the foreign transaction fees wipe out any "rewards" you may gain.

So.... what is the verdict on rewards cards?   After my year-long experiment, I have come to the conclusion that they really are no real bargain.   They are a loaded handgun pointed at your head, waiting to go off and bankrupt you or at least cause a painful credit card crises that could take years to pay off.

And the payback?  Pennies at best.   You won't get substantially richer with a rewards card, even assuming you play their game right and make all your payments on time and pay off the full amount.   And this is assuming you don't fall into the trap of spending more money when you get the card - a very easy trap to fall into.

Rewards are the bait in a trap.  As my reader noted, it may be possible to steal the cheese but bear in mind that the cheese he is referring to is indeed bait in a deadly trap.    Obsessing about stealing the cheese tends to obscure the fact that you are dealing with a trap.

All I can say is, use these "rewards" cards with extreme caution - and don't kid yourself that you'll get rich this way.