How Does the Rewards System in Credit Cards Work?

In this article, you will learn how the rewards system in credit cards works. You will also learn how banks recover the cost of these rewards.

In 2011, when the great recession hit the world, corporate giants were unable to make money through mortgages. That is when they shifted their focus from corporate lending to consumer lending. They started offering lucrative deals on credit cards in the form of rewards to attract more customers. With better deals, more customers started owning reward cards. British Airways Visa was one of the first companies to offer 100,000 miles sign up bonus.

Table of Contents

• Rewards System in Credit Cards
  • What are the uses of reward points?
  • Can reward points be converted into cash?
  • What is the value of 1 reward point?
• Limitations on the rewards system in credit cards
• Who is actually paying for reward points?
• How to use the rewards system for your benefit?

Rewards System in Credit Cards

You get reward points whenever you make specific payments using a credit card. You can get these reward points in the following ways:

1. Certain card providers offer reward points as sign up bonuses. 
2. You can also get reward points in the form of referral bonuses as an existing cardholder. This occurs when you refer to the credit card via a link to someone. The percentage of reward points depends on the card provider.
3. Some card providers directly deposit the cash value of the redeemed points in your account balance. 

What Are the Uses of Reward Points?

The amount and value of reward points vary from one card provider to another. Card providers put a minimum limit to the number of points only after which you can redeem them. You can redeem your points online through net banking, mobile banking and applications. Through reward points, you can:

• Make specific purchases
• Get discounts on products
• Buy gift cards
• Get subscriptions 

Can Reward Points Be Converted Into Cash?

“Yes, some card providers do allow the conversion of reward points into cash. Not all card providers allow this conversion.”

What is The Value of 1 Reward Point?

“Each credit card provider has its own system for calculating the value of 1 reward point. It might be equal to 25 cents or 1 dollar. There is no universally fixed value for reward points.”

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Limitations on Rewards System in Credit Cards

Although the reward system in credit cards seems lucrative, card providers set a number of limitations on it. It is important to note that you:

• Do not get rewards for each payment
• Cannot redeem all the points
• Have to pay a certain fee on reward redemption
• Can only redeem rewards after reaching a minimum limit

Who is Actually Paying for Reward Points?

Have you ever wondered how much of these rewards cost banks? The answer to this question is pretty simple. You and I, the customers, are paying for these rewards. Let us know more about it.

1. Redemption fee: Card providers offer rewards to you but these are not entirely free of cost. You should know that the redemption value is often not equivalent to the reward points. They charge a certain fee on point redemption. This means that most amount is being lost in the redemption process.

2. Interchange fee: This is one of the most tactful ways in which banks recover the cost of rewards from you as a customer. Whenever you make a payment through a credit card at a store, the card provider charges the store with an interchange fee. This fee is equal to a certain percentage of the sale.

Since store owners have to pay this fee from their own pocket, they increase the retail prices for all customers. This means that the customer has to pay for the interchange fee as well. 

3. Limited value: Card providers offer most reward points on schemes that might not be useful to you. You might be getting offers on products that might not be popular, outdated or might have limited purpose. They also put a cap on the amount that can be redeemed. This means that you might have to pay a large sum for getting that offer. 

Learn how credit card companies are making money

How To Use The Rewards System For Your Benefit?

While there are a number of limitations on the reward system in credit cards, you can still smartly use this reward system in your favour. Following are some effective ways for choosing a suitable reward credit card:

1. Suitable Reward System: Choose a card that offers a reward system that is the most suitable for your needs. For example, if you travel a lot in your car, you can choose a card that offers a fuel surcharge waiver, reward points or cashback on fuel. If you are a foodie, you can choose a card that offers dining related offers. 
2. Feature Usability: Different cards offer different schemes. You can opt for cards that offer useful features such as zero liability on stolen credit cards, easy EMI options or provide offers on utility bills or purchases.
3. Cashback schemes: You can choose cards that offer better cashback schemes rather than cards that offer reward points for non-essential items. You can also choose cards that offer referral and sign-up bonuses. 

Conclusion

A reward system is an add-on to a credit card. You cannot label this system as a negative. However, it is not exactly free of cost. As a cardholder, you should not rely completely on reward points. 

If you plan to opt for a reward credit card, you should smartly choose a card that offers suitable rewards for you. It is also important to carefully go through the terms and conditions while choosing a reward credit card.