Rewards Credit Cards: A Trap or an Opportunity?

Past generations might have been horrified at the idea of borrowing for daily living.  These days, if you’re smart, you can use your spending to get rewards and other perks through credit card rewards schemes. But how do you know if you’re getting a fair deal?

How do rewards schemes work?

If you have the financial stability and self-control to pay your credit card off in full every month, it could be worth looking at rewards schemes.   The concept is quite simple - you borrow and earn points to get rewards such as frequent flyer miles, appliances or cash back on purchases.

Picking a scheme that’s good for you can be hard - there are more than 20 different rewards credit cards in the market at the moment.  Read the tips below to help make sure you’re really earning yourself a reward and not being induced to borrow more than you otherwise would have.

Picking the right rewards card

Deciding which, if any, rewards card is right for your situation can be a tricky process. First up, find out how much you generally spend on your credit card.  How much you borrow should drive how you approach choosing a card. If you’re a low spender, chasing rewards with a platinum card is only going to see you borrow more.

Next, consider what types of rewards would best complement your lifestyle and things that you currently do.  If you’re planning a holiday, a card with travel rewards might be a good option.  On the other hand, if you’re trying to save for a house or a new car, consider whether a cash-back rewards card could help you achieve your dreams faster.  Here, the key is to not to look at changing your behaviour. If you change the way you spend to accumulate rewards, you’re likely to spend more over the long run.

• Trap #1: Increasing your spending to get better or more rewards

• Trap #2: Signing up for rewards that don't match your current needs or are optional extras

Make sure to check the annual fees charged on the card.  Sometimes paying a higher fee is a better decision, especially if it means you get complimentary extras (such as purchase insurance or airline lounge passes) or if your earn rate is higher.  On the other hand, some annual fees are higher than the rewards an ordinary spender would earn, so check the offer against what you’re likely to spend!

• Trap #3: Paying extra annual fees in exchange for boosted rewards - these fees are probably more than the value of any reward you earn

Let’s see how a little bit of careful research could help you make your dream happen sooner

Opting for Airpoints

Let’s assume you head on holiday once or twice a year and choose a card offering Airpoints Dollars.  Let’s assume you spend about $3,000 a month on your card, about the national average. You might pay about $65 in annual fees and get 1 AirpointTM for every $120 spent.   You’ll earn 300 Airpoints so, after fees, your net gain is $235.

Looks good.  Now it’s time to travel.  You find that another airline flies the same route (say Auckland to Los Angeles) for $1,850 while Air New Zealand offers $2,200.  Being a difference of $350, you haven’t actually saved any money through your rewards credit card this time. Net loss: -$20.

Travel insurance

Often Platinum cards give you general travel insurance for overseas travel from and back to New Zealand.   If you go on holiday once a year, this could offer you value.

You’ll want to check whether the travel insurance policy on offer is going to cover everything you need it to.  You may be caught short if the policy is too narrow or if you could have bought a more comprehensive cover for less than the card’s annual fee.

Cash-back rewards

Perhaps you would rather have money put back into your credit card account.  Remember, cashback cards often have tiered spending. So if you spend less than $10,000 a year, then you might only get 0.5% cash back.  With many providers, this is usually a net loss after your annual fee is taken into account. However, if you’re around that national average of $36,000 per year, then you might come out with a net gain (after fees) of $300 - being 1% of your spend. This type of saving adds up over the years, but applying for credit cards and paying the bill each month can be a lot of work.

Other credit card currencies

You might prefer merchandise through credit “currency” rewards.  It can be hard to work out how much these rewards are really worth. If you are able to buy the same thing for less than the value of the credit card “currency”, you’re probably worse off.   There can also be the sense that, for example, 36,000 Hotpointsis more valuable than having 250 Airpoints Dollars.   In reality, you spend exactly the same amount to earn them.

Debt consolidation

If you’re feeling stuck, don’t forget that credit card providers are sometimes happy to buy your debt for 0% interest.  So if you’ve been finding it difficult to keep track of lots of different cards, consider moving the debt on your highest interest rate cards to one of these options.

Do read the terms carefully - you’ll typically pay interest from day one on any new purchases on your consolidated loan credit card.

If you’d prefer to avoid the temptation of a new credit card, or if you have several different types of high-interest debt, a debt consolidation personal loan may be a good option for you. These loans often come with more flexibility than a balance transfer, especially if you need longer than the standard six to twelve months to catch up. Check out our debt consolidation calculator to find out how much you could save.

It’s also worth saying here that, as always, you should be mindful not to borrow more than you need to. You might not even need a credit card.

Quick tips

Now that you have a good grasp of potential benefits and common traps associated with credit card reward schemes, you might want to consider revisiting your existing arrangements.

When you do, bear in mind that:

• You’re most likely to be a good candidate for rewards schemes if you routinely pay off your credit card in full.

• You’ll be tempted to sign up for rewards that aren’t good for you or lock you into one-provider when it is time to redeem your rewards.  Make sure you know what your needs are, rather than your wants.

• Don’t forget - if you change the way you spend to accumulate rewards, you’re likely to spend more over the long run.

• Read the detail of the offer and the card.  You may find that a deal looks really good but notice that there’s a catch that makes it much less worth your while, and your dollar.