Balancing Credit Card Rewards with APR
How to ensure your bonuses aren’t offset by interest added at the end of the month.
One of the primary benefits of using credit in today’s financial world is all rewards and bonuses you can earn when you put purchases on your credit cards. Between travel miles, membership rewards and cash back, there’s plenty of good reason to put purchases on plastic instead of pulling out cash.
On the other hand, those rewards are really only truly beneficial if you’re paying off the debt quickly. Otherwise, what you earn isn’t nearly as much as what you pay in the form of interest added. With that in mind, we’ve put together the information below to help you understand how to ensure your credit card rewards are not offset by too much added interest.
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Understanding interest rate grace periods
By law, every credit card has an assigned grace period set up in the billing cycle. Basically, if you start a month with a zero balance and then make purchases throughout the month, interest will only be applied if you do not pay off the balance in-full before the end of the grace period. If you pay off the balance, then no interest gets added and you’re not paying anything extra for those purchases you made. As a result, you get the full benefit of any rewards you earn.
On the other hand, if you don’t pay off your balance in-full before the grace period expires, then interest gets applied to that balance. But that’s not the worst of it – if you start a month with a balance, then the grace period doesn’t apply at all. So every purchase you make in the next month would have interest applied from Day One. Since reward credit cards tend to have high interest rates, the rewards you earn are almost always completely offset by applied interest.
With that in mind, the only way you really get the full benefit of the rewards you earn is by paying off your balance in-full every single month. Otherwise, the rewards are offset by interest added – and the longer you allow your balances to carry over, the more interest you add.
An example of offset rewards using cash back
Cash back credit cards are fairly straightforward, so for the purposes of this explanation, we’ll use a cash back credit card to explain the issue you face with rewards being offset by interest added.
Let’s say you have a credit card where you earn 5% cash back on groceries and dining out. So you use this credit card to make all of your food purchases in a given month. Give or take, you spend about $500 a month on food for your family. So you earn about $25 cash back every month.
That’s great – especially if you’re being strategic and paying off the debt on that credit card in-full every month. You earn cash back on the food you’d be purchasing anyway, then put the money you have allocated in your budget for food to paying off this credit card every month. It’s the perfect system.
… Until you let a balance carry over from one month to the next, that is.
Let’s say one month you really splurge and eat out too much, entertain guests, and run up a few bar tabs. So instead of a $500 balance to pay off, your balance is $800 and you don’t have enough money in your budget to pay it off in full. So you pay off $500, but carry a $300 balance over to the next month.
Now that $300 gets interest applied. Even with a relatively low rewards APR of 15% on that credit card the interest added equals $45. So for the month where you spent $800, you earned $40 in rewards but then spent another $45 on interest added. So you have a net loss of $5 already.
And keep in mind from above, that the grace period only applies if you start the month with a zero balance. Since you’re starting the next month with a balance of $300, every purchase you make in that month will have interest applied from the moment its swiped. So while you earn 5% cash back, you pay 15% interest. At best, your cash back for the month is like an interest rate rebate. But you’re not really gaining – and you won’t until you pay off the balance and start a month with no debt.
Other types of reward credit cards are just as bad
If you think this balancing act only applies to cash-back credit cards, think again. Consider that the cash value of each mile you earn on a travel rewards credit card is only worth about $0.10-$0.15. Even if you have one of the newer travel miles credit cards that offers 2 miles for every $1 purchased, that’s still only a cash value of $0.20-$0.30.
Meanwhile, if 15% APR gets applied you’re looking at $0.15 in added interest for every $1 transacted – and again, that’s only if you pay off the balance in the next month. Otherwise, that 15% gets applied billing cycle after billing cycle until the balance is paid.
Of course it’s a little harder to do the math, but point reward cards are no different when it comes to offset interest. Simply put, if you’re not paying off your balances in-full at the end of every month, then you’re not really getting the benefit that you think you are using a rewards credit card.
Opt for low APR on large purchases
With all of the above in mind, part of your credit card strategy needs to be tailored to ensuring you can pay off your rewards credit cards in-full without fail every month. This maximizes the benefits of using a rewards card at all.
At the same time, if you know that you have a purchase or series of purchases that you need to make that you won’t be able to pay off in-full before the end of the month, then don’t bother putting that purchase on a rewards credit card – instead opt for your credit card with the lowest APR that you have. This means less interest gets applied each billing cycle as you attempt to pay off the debt.