How do credit card rewards work?

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Rewards cards give you the opportunity to earn cash back, points, or miles on your spending. This boosts the value of using a credit card instead of cash or debit cards. These cards are ideal if you hope to maximize your spending and get the most from your credit card.

However, the intricacies of rewards programs can be confusing, especially when managing multiple cards. That’s why it’s important to understand how these programs work to make the most of your rewards card.

What is a rewards credit card?

A rewards credit card is a type of credit card that gives you something in return for each dollar you spend. Rewards come in different forms, including airline miles, cash back, or points.

You can earn rewards through a flat-rate structure where rewards are consistent for all purchases. Or, you can earn tiered rewards, with higher earning rates for specific categories, like dining, groceries, or travel.

Rewards can be accumulated over time and redeemed for a variety of perks, such as travel, merchandise, gift cards, or statement credits. The more you use your rewards credit card, the more rewards you can potentially earn. 

It's essential to pay your balance in full each month to avoid interest charges, which can quickly negate the value of any rewards you've earned.

Types of credit card rewards

There are three main types of rewards — miles, cash back, and points.

Cash back 

Cash back is a type of reward where cardholders can earn a percentage of their purchases back as cash. For example, a card that offers 3% cash back on all purchases would earn $3 in rewards for every $100 you spent on the card.

You can redeem cash back as a statement credit, a deposit into a bank account, or a physical check. The amount of cash rewards depends on the specific card. Some offer different cash back rates in certain spending categories, like gas or groceries.

For example, with the Chase Freedom Unlimited®, you can earn a consistent 1.5% cash back on all expenses, plus higher cash back rates for specific spending categories, such as 5% cash back on Lyft purchases, 5% cash back on travel booked through Chase, 3% cash back on dining, and 3% cash back on drugstore purchases. 

Choose a cash back card that aligns with your spending habits. If you spend a lot on groceries, a card like the Blue Cash Preferred® Card from American Express, which offers 6% cash back at U.S. supermarkets (on up to $6,000 per year in purchases, then 1%), could be a great fit.

Points

You can redeem points for various rewards, such as travel bookings, merchandise, gift cards, or statement credits.

The points you earn depend on the amount you spend. Some credit cards offer bonus points for specific spending categories.

Points can typically be redeemed for a variety of options, including travel, gift cards, merchandise, or statement credits. 

Some co-branded travel credit cards let you earn loyalty points for a specific hotel chain. Other cards allow you to earn points within a card issuer's own program, including American Express Membership Rewards, Capital One Miles, and Chase Ultimate Rewards.

The value of each point depends on the specific card and how you choose to redeem them. Look for a points rewards card that offers flexible redemption options and valuable transfer partners. 

For example, the Chase Sapphire Preferred® Card allows you to transfer points to popular airline and hotel loyalty programs, such as United MileagePlus® and Marriott Bonvoy™, often at a 1:1 ratio.

Miles

You can redeem miles for airline tickets, hotel stays, or other travel expenses.

The number of miles earned is based on the amount spent, and you can accumulate these miles over time. If you have a co-branded airline credit card, you can also earn frequent flyer miles for the partner airline.

Some cards will have restrictions on how you can use your miles. For example, some cards only allow you to use airline miles to book flights. Others let you use miles to book other types of travel, like hotel stays and car rentals.

For example, the Citi® / AAdvantage® Platinum Select® World Elite Mastercard® allows you to earn AAdvantage® miles on everyday purchases. It offers benefits like preferred boarding, complimentary checked bags, and inflight food and beverage discounts. Plus, new cardholders can enjoy a sign-up bonus if they spend a certain amount within the first year.

Earning and redeeming credit card rewards 

Once you start shopping for a rewards card, you'll notice how unique each individual card is. But knowing how they differ and what to look for can help you find the right credit card for your needs.

How to earn credit card rewards 

There are several ways to earn credit card rewards, including:

1. Making purchases: Most rewards credit cards earn points, miles, or cash back on every purchase you make.
2. Welcome bonuses: Many cards offer generous welcome bonuses to new cardholders who meet a certain spending requirement within the first few months of account opening.
3. Bonus categories: Some cards offer bonus rewards on specific spending categories, such as dining, travel, or groceries.
4. Referral bonuses: Certain cards offer bonus rewards when you refer a friend or family member who applies for the card and is approved.

How to redeem credit card rewards 

Some common redemption options include:

• Statement credits: Apply your rewards as a credit to your account balance.
• Travel: Redeem points or miles for flights, hotel stays, rental cars, or vacation packages.
• Gift cards: Exchange your rewards for gift cards from popular retailers or restaurants.
• Merchandise: Use your rewards to purchase items directly through the credit card issuer's rewards portal.
• Charitable donations: Some programs allow you to donate your rewards to eligible charities.

Compare the redemption values of different options to ensure you're getting the best deal for your rewards.

Making the most of your credit card rewards 

Earning rates vary from card to card

Each credit card has its own rewards program with specific earning rates. Some cards offer a flat rate of rewards on all purchases, while others offer elevated rewards in certain categories.

A good rule of thumb is to pick a flat-rate card with a high earning rate, or a card that offers the most rewards in categories you regularly spend in.

Bonus offers are a big deal

Credit card bonuses can be highly valuable. They provide cardholders with many rewards after spending a certain amount within a specific amount of time of opening the card.

These bonuses can substantially boost a cardholder's rewards balance. Consider which cards offer sign-up bonuses you can realistically meet. You don’t want to wind up overspending or going into just to make the bonus.

Some rewards are more valuable than others

Not all credit card rewards are equal. The value of your card’s rewards depends on how easy and flexible is it to redeem your rewards.

Certain rewards, like airline miles or hotel points, can only be used for specific things. Cash back rewards offer more versatility as they can be used for any type of expense.

General credit card rewards programs often provide more consistent value and greater flexibility compared to airline and hotel rewards programs. You can redeem rewards for travel and non-travel expenses, or transfer them to travel partners.

To assess the value of your rewards, divide the booking's cash cost by its cost in points or miles. Then, compare the results to estimated values to see if using rewards is a good idea.

What to do before you get a rewards credit card

Rewards credit cards aren’t all freebies and discounts. Many come with annual fees, and almost all charge high interest rates if you carry a balance month to month.

"Interest and finance charges can snowball quickly, and for many cards, at a very high rate," says Danny Cieniewicz, certified financial planner at Hyperion Financial.

That’s why it’s important to be strategic. Cieniewicz offers some tips to consider before you get a rewards credit card:

• Create a monthly budget. Ensuring your budget is solid before using a credit card is a great idea. This ensures you’re spending responsibly and won’t take on excessive debt.
• Make sure you'll never carry a balance. Carrying a balance on a credit card accrues interest charges, potentially leading to long-term debt. "With monthly finance charges that will rack up every time a balance is left on the card, any points earned can quickly be dwarfed by charges going back to the credit card company," says Cieniewicz.
• Commit to paying your balance in full each month. Paying off your balance in full each month can help maintain a good credit score, avoid interest charges, and promote smart financial habits.

Frequently asked questions about rewards credit cards

The bottom line

Rewards credit cards can give your finances a huge boost if you use them the right way. But they can also harm your long-term goals if you don’t use your card responsibly.

In addition to deciding on the type of rewards card to get, you should also consider whether you need one in the first place. If you believe you can use credit smartly, there are many great rewards credit card options out there.

Editorial disclaimer: Opinions expressed are author's alone, not those of any bank, credit card issuer, or other entity. This content has not been reviewed, approved, or otherwise endorsed by any of the entities included in the post.