The Dark Side of Cash-Back Credit Cards

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Cash-back credit cards are the latest hot trend in plastic. According to LowCards.com, in the third quarter of 2010, 41% of credit-card offers involved cash-back cards, up considerably from just 28% a year earlier. For all of these cards' rewards , Fools should be wary of their hidden dark side.

Researchers at the Federal Reserve Bank of Chicago recently discovered what banks had probably already figured out: When cardholders are offered cash back, they tend to spend more, and rack up more debt. With an added 1% cash-back reward, the Fed found that cardholders earn an average of $25 in cash back per month. But they spend $68 more per month, and pay off less of it, increasing their overall debt level.

Don't believe the hype
Card issuers are getting aggressive. JPMorgan Chase's ( JPM ) Chase Freedom Visa recently offered $100 for customers who spent $500 in their initial six months. While that sounds tempting, the fine print reveals that the card caps the popular 5% cash-back rewards it offers on certain spending categories at $75 per quarter, after which the card's standard 1% reward applies. Similarly, Citigroup's ( C ) Citi Platinum Select card limits your rewards to $300 per year.

You might have been tempted by Discover Financial Services' ( DFS ) Discover More card, with its 5% cash back on travel and restaurant purchases made over the first quarter this year -- but eligible purchases were capped at $800, meaning that the reward tops out at just $40. Before you sign up for any of these cards, run the numbers to make sure you're really getting everything you expect.

The more you spend, the more the issuing banks make on each transaction. Interestingly, these cash-back cards also motivate us to pay with them, when otherwise we'd have used cash or another credit or debit card. Thus, the banks grab a bigger share of our overall spending.

That said, if you can keep your spending in check, at least some of these cards are definitely worth investigating. The Discover More $100 Cash Back and Chase Freedom $100 Cash Back cards won praise from LowCards.com, along with American Express '( AXP ) Blue Cash card, the PenFed Visa Platinum, and the True Earnings card, which is offered through Costco (Nasdaq: COST) and American Express.

Study each candidate's details , and remember that in general, such cards carry higher interest rates. If you don't pay your balance in full each month, those interest rates can rapidly outpace any rewards you might receive. When it comes to cash-back cards, make sure they're the ones paying you -- not the other way around.

Double-check that none of the worst credit cards lurk in your wallet.

American Express, Costco, and Discover Financial Services are Motley Fool Inside Value  picks. Costco is a Motley Fool Stock Advisor  recommendation. The Fool owns shares of Costco and JPMorgan Chase. Try any of our investing newsletter services free for 30 days.

Longtime Fool contributor Selena Maranjian owns shares of American Express and Costco. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool is Fools writing for Fools .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Personal Finance , Credit and Debt

Referenced Stocks: AXP , C , DFS , JPM

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