Cashing In: The Dark Side Of Credit Card Rewards
Incentive programs boost card usage but penalize lower earners and small businesses
Last year I applied for what every loyalty point earner craves: an American Express Platinum card. The solid metal spending tool arrived in a crafted walnut box, a celebration of my faithfulness to consumer credit and spending. I would now enjoy a multitude of privileges every time I swiped my plastic…sorry, my ‘metal’…
More than a trophy, my Platinum card actually helps me save some serious cash. Over the past twelve months I’ve used my reward points to purchase a new television on Amazon, save $200 on Uber taxi rides, and avoid foreign exchange fees when travelling abroad, plus lots more.
Loyalty Has Two Sides
All these generous donations to my wallet don’t come for free. Credit cards fund their loyalty programs from the income they collect elsewhere, including customer fees for late payments and interest income on unpaid balances.
Americans paid $121 billion in credit card interest in 2019 - an increase of 7% from $113 billion in 2018. This year the nation’s interest bill is expected to climb even higher, spurred by pandemic-driven credit card spending.
Theoretically these high rates of interest are levied on all cardholders, but in reality it’s not the loyalty point seekers who are paying the bulk of them, but lower income cardholders with limited access to affordable credit. Many of these cardholders - students, low income workers and undocumented earners among them - have no choice but to pay their cards’ hidden fees and disproportionately high interest rates because they have no alternative.
The Business Of Rewards
As strange as it sounds, we can also thank the financial crisis back in 2008 for fueling the explosion in credit card reward programs. Following the crisis, new financial legislation limited the fees banks could charge merchants (called interchange fees) for debit card transactions to 1%, but left credit card fees unregulated. As a result, banks focused on growing their lucrative credit card operations where processing fees can run as high as 4%.
With the exception of gas stations and some smaller retailers, merchants do not directly pass along these steep fees to their card customers over those who pay with cash, but in reality all consumers take the hit through higher prices for goods and services. It’s pretty nuts that banks can justifiably charge merchants upwards of 4% to process transactions, especially when they do the same job for debit card payments for just 1%.
The high fees may be bad news for businesses, but all that frothy profit is helping banks fund their cash back deals and other rewards. It’s a bit of a bizarre system, with the banks incentivizing cardholders through shopping rebates funded by the merchants that pay them hefty fees.
Let’s look at an example of this circular money loop using the Capital One Savor One Rewards card, which pays 2% cash back on grocery store purchases:
In this example, the shopper uses her credit card to purchase $100 of groceries, but the supermarket only receives $96 from the bank. The bank retains $4, of which it credits $2 back to the shopper on her next billing statement.
In the end, credit card loyalty programs may seem like a win-win for card users, but taking a step back their benefits are less straightforward. Merchants pass along their high credit card costs to all their customers through higher prices. It’s the lower income consumers who unfairly absorb these extra costs, while higher income shoppers get a bit of a break by earning some of them back through their credit card loyalty programs.
Credit equity is a complex problem, but one thing is clear: The banks never lose out.
Postscript: My Wooden Box
I was pretty psyched by my new credit card’s fancy wooden display box sitting on my desk, before it began to unnerve me . What, exactly, was I supposed to do with it? Display my credit card rather than keep it in my wallet? The box began collecting bits and pieces before I eventually packed it into the goodwill bag.
Perhaps American Express could redeploy the costs of their wooden boxes to reduce the debt burdens of some of their less fortunate cardholders.
Now that’s a reward program well worth considering.