Credit card reward programs carry risks

Credit card reward programs come with a seemingly endless variety of perks and points systems — and may seem like a win-win situation — but financial experts say consumers ought to think things through carefully before attempting to spend their way to a free trip.

There is certainly an opportunity, particularly if you're paying off your monthly balance, but the lure of the programs can obscure financial realities, says Patricia White, executive director of the non-profit Credit Counselling Canada.

"People get caught up in the rewards program and don't really take the time to understand it," she said.

The benefits of certain cards are a frequent selling point in advertisements and can range from cash-back rewards to travel points to upgrades and discounts on flights, hotel rooms and rentals.

A new online payment platform called Plastiq issued a release last week touting the benefits of its service in part because it allows customers to reap the rewards of credit cards.

Plastiq says it allows users to pay for goods and services that are usually unavailable for credit cards — including transactions with government entities, universities and rental property owners — for a fee of two per cent.

Paying off your bill is key

One of the most obvious pitfalls of using a credit card to gain rewards is carrying a monthly balance because you'll get charged interest that can easily wipe out the benefits, which usually work out to around one to two per cent of the amount charged.

"They're not really thinking that if they're carrying a balance they're paying maybe 18 to 24 per cent interest [per year] on that amount that they're carrying," says Elena Jara, director of education with Credit Canada Debt Solutions, a charity that offers free credit counselling and debt management services.

"So it doesn't really justify the percentage that they're getting back," she said.

People also need to consider whether they pay an annual fee when weighing the pros and cons of a particular program, which can also eat into the fairly small percentage returned. 

If you're paying $100 a year to get a one per cent cash back, for example, you'll need to spend $10,000 to get the annual fee back. On the other hand, if you need or want that particular card and you're going to charge money on it regardless, the one per cent, or more, can be a nice bonus.

Some cards charge hundreds of dollars in annual fees but come with a plethora of perks — free upgrades at hotels, access to airport lounges, discounts on tickets — which is likely worthwhile for someone who travels a lot but isn't for the casual traveller.

Avoid impulse buying

Many financial experts also suggest avoiding impulse buying and not spending simply for the purpose of accruing points or cash-back rewards.

"For consumers who can really control themselves well, I think it's a great benefit to them," said Andrew Ching, a marketing professor at the University of Toronto, adding that a number of people pay off their bills each month. 

The appeal of reward credit cards is fairly straightforward, Ching said, because consumers are getting something tangible back for purchases.

Other loyalty programs, which offer points that can be used to buy future products for instance, can entice consumers by almost appearing like a game. People will buy goods at certain stores simply to get the extra points, he said.

Because the programs are so popular, most companies offer new deals in an attempt to gain customers from their competitors, Ching said. It's not really about trying to sign people up for their first credit card.

"This is a way to grab market share," he said.

They are also unlikely to go away because the first bank to do so would likely see many of its customers switch to cards with some type of reward program, Ching said.

Importance of reward cards 'ramping' up

Although it might seem to be intuitive, it's unclear whether rewards programs actually increase the amount people spend instead of simply shifting spending.

"We know that certain rewards programs encourage people to put more spending on credit cards at the expense of using other payment methods like cash and debit," says Mary-Anne Huestis, a co-principal at research firm MarketSense Inc.

A study released in 2010 by the Federal Reserve Bank of Chicago found that a one per cent cash-back reward card did increase spending by about $68 per month during the first three months but that increase was offset by reduced spending on other cards.

The importance of rewards cards, however, has been "ramping" up over the last few years as some consumers learn to maximize their returns, Huestis said.

Based on information collected from 5,000 people last fall, she said a little more than 50 per cent of consumers reported that they only carry cards with a rewards program and actively search out ways to accrue benefits.

One area of growth recently has been rewards for grocery purchases, she said, adding that some banks are also introducing benefit programs for debit cards.

Pick your card carefully

Jara, from Credit Canada Debt Solutions, said most people need to do some research before signing up for cards. Consumers need to consider any annual fees and the card's interest rate, as well as what type of reward program you're joining.

If you don't travel very much, don't get a card that offers trips and instead think about one that offers cash back.

With points cards, people need to think about what sorts of rewards they want — a plane ticket, for example — and how much spending is needed to achieve it.

However, many people don't do this, Jara said.

"I think we're sometimes a little intimidated by the language that is presented because it's not simple, it's not easy to understand," she said.

For the financially savvy — and those with money to pay off monthly balances — there are a lot of benefits to rewards cards, Jara said.

"They could get a free trip, they can get free stuff," she said. "So yes, if you're using that credit card wisely, absolutely you can benefit."