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Are Credit Card Rewards Funded By The Irresponsible?

by The Happy Rock on July 25, 2008

I have already shared my analysis of the best cash back credit card, and for those of us that have the financial discipline and habits to not overspend and pay off the bill each month, credit card rewards can be a nice bonus with relatively little effort.

My question is whether or not the fiscally responsible are living off the debt and fees of the fiscally challenged. Before you dismiss me or get up in arms, let’s take a look at the math.

Credit card companies card charge about 2% give or take for interchange fees on each transaction.  By spending about just $1,000 to $2,000 a month on a Chase Freedom card you can easily earn over 2% back in cash.  For someone like me who never pays a penny in fees or interest it seems like Visa is actually losing money.

If they are losing money on me and the rest of the hard core rewards crowd, they must be making a fortune off someone else to compensate. Their profit most likely come from people who get rewards card for the cash back or points and end up carrying a balance.  Profits also come from those that are paying late fees, annual fees, and those that get hit with high interest rates.  Finally they also make a profit on transactions that don’t have rewards attached to them like regular credit card charges and debit transactions.

Does the math add up? Do you agree? Does it effect the way that you view credit card rewards?

{ 10 comments… read them below or add one }

Christine July 25, 2008 at 6:52 am

It’s a business. They would stop offering rewards in a heartbeat if they were actually losing money on the deal.
That 2% cash reward is probably skimmed off the top of the guy who’s still paying 29.5% (and late fees) on that cash advance he used to pay the rent back in November ’07.

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Meoip July 25, 2008 at 7:51 am

The credit card companies make money by charging more to swipe Rewards Card. When I looked into taking Credit Cards for work the reward cards fees were about 1% higher than a standard credit card. So it’s not the irresonsible consumers that are funding your thrift it’s the stores, especially the smaller ones, that take the hit.
Once the card company gets your extra one percent I’m sure they pitch it into a high interest holding account until they pay you at the end of the month, quarter, 6th month or year depending on the card.
If you spend $1000 at Pops Books and us your rewards card Pops Books gets charged $25.20 (there is a .20 transaction fees) if you use your standard card it only costs them $15.15. The Card company takes the extra $10 which you are owed say $10 in rewards back and palces it in a holding account that earns 5% interest, they hold it for a month to earn $.50 on it and then give you $10. They just made $.50 and multiple that over a few millions and they do well.

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plonkee July 25, 2008 at 8:01 am

Yes, I’m sure they’re making the money that’s used for rewards on the people that pay lots of interest and fees. It doesn’t affect the way I feel about using rewards because I’m pretty sure the credit card companies aren’t going to reduce their charges if they scrap rewards systems.

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Sue July 25, 2008 at 9:03 am

I guess I don’t exactly understand the question in your post. The credit card company wants to have you as a customer. They do rec. money on the purchase by the person who you are buying the product or service. A certain percentage of every sale goes to the credit card company. That is why some establishments try to head off consumers from using credit if the is under a certain dollar amount. They are being charged to accept by credit card.

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Sue July 25, 2008 at 9:10 am

I reread your post. Looks like you are aware of the charges put on the seller.

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Sue July 25, 2008 at 11:39 am

Interesting question? Are they currently earning money from you? We will assume not if you only used the credit card for items that you get 3% back but if you use the card for things that don’t qualify for the 3% back then yes.
There is always the potential to finance.

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Pete @ biblemoneymatters July 25, 2008 at 12:40 pm

Rewards credit cards are not a good thing for most people because they end up spending more (because hey, i’m getting rewards!), and often don’t even claim the rewards. I wrote a post about this a while back. Linked in my name.

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Double Eagle July 25, 2008 at 1:36 pm

In general, credit card companies are blood sucking leeches. If you’re not paying a penny in fees or interest but are getting reward bonues, then someone else is footing the bill.

However, we’re all in charge of our own financial destiny so I wouldn’t feel guilty about it. Also, if you think about it, there’s not much difference between that and walking into a department store and haggling 15% off a large cash purchase. The fact that most other people paid full price means they can give you a discount. If they gave everyone the discount (“reward”, if you will), then they’d be out of business.

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Mommychicky July 25, 2008 at 6:03 pm

As a former employee of a major credit card bank, I don’t have a bit of pity for the issuers. Trust me, they are making there money and then some. Now, would I ever get involved in a rewards program that charged me to participate? Heck no. But I will be the first to admit that when I started working for said bank and realized that if I started using my fee free rewards credit card the same way I used cash/debit, I could get something back for things I already had to buy, you bet I started using that card. On the issue of whether these programs are funded by those who are irresponsible, honestly most of the credit card industry is funded by those fees and we each decide how we handle credit. It’s really too late now to turn back from the lure of easy credit, but that shouldn’t stop us from being educated consumers and opposing the outrageous fee structures present on todays cards. (Even if they are buying art and antique cars for the CEOs of the issuers :0)

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John @ Curious Cat Investing Blog November 27, 2008 at 12:20 am

I suppose you could look at it that way but really I think it is 2 things. First, the credit card companies figure on average they will make money on you both through fees to merchants and fees to you (but if you are one of those that doesn’t ever have fees they might not). Second, because their fees are so high – they might overpay a bit so maybe they really do lose money (instead of say paying 1% cash back and making a little). If the second is true it wouldn’t be surprising for the maximum payout go down as they stop making huge profits off those that see the big credit and buy more, pay more fees…

But the same would hold true for anything – at most any store they have loss leaders. If you only buy those they might lose money on you. If you buy just gas with a credit card the gas station might lose money on you or close – many stations rely on people buying extras…

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