How Cash Rewards Credit Cards Really Work

By Miranda Marquit. Last updated 24 November 2014. 1 comment

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Anymore, it doesn't make a lot of sense to get a credit card if you aren't receiving some sort of rewards benefit. If you are going to use credit to make purchases, then you might as well recoup some of that. However, there are hundreds of these types of rewards and cash back credit cards. They may all sound similar, but depending on your spending habits, you would see very different levels of rewards with different cards.

Cash back cards allow you to get "cash back" for your purchases. Rather than getting points for your purchases and then using those points to get various merchandise or travel rewards, you get actual money back (most of the time in the form of a statement credit). What varies from card to card is the amount of cash you get back, in what categories, and how you redeem them.

You want the best possible cash reward card for your individual financial situation. Here's what to consider as you look for a cash rewards credit card. (See our picks for best cash back credit cards)

How You Earn Cash 

Not all cash back cards have the same mechanism for accumulating rewards. There are cards that work by giving you cash back on a percentage of your purchases, and some that work on a points system.

Earning Cash through Points

In most cases, cash rewards cards that offer points are pretty straightforward. You get one point for each dollar that you spend. Some cards will offer extra points by shopping at a specific store, or by spending in certain categories.

For example, Credit Card XYZ offers 3x points for supermarkets, 2x points for gas, and 1 point for other purchases. Your points would looking something like this:

  • Shopping at Whole Foods Market: $87; Points: 261 (87*3)
  • Getting gas: $43; Points: 86 (43*2)
  • Shopping at Home Depot: $60; Points: 60

It's important to realize that one point does not translate into a dollar of cash back. In most cases, each point is akin to earning 1% cash back. So for the purchases above, those points are worth about $4.

You can see, though, how the extra multiplier help rack up rewards points quickly.

Earning Cash through % Back

Cars that offer a percentage of cash back on your purchases work the same way as the points above. But instead of going through the extra step of translating the points into cash, the calculation is done directly.

For example, if Credit Card ABC offers 3% back for supermarkets, 2% for gas, and 1% for other purchases, the breakdown would look like this:

  • Shopping at Whole Foods Market: $87; Cash back: $2.61 (3% of $87)
  • Getting gas: $43; Cash Back: $0.86 (2% of $43)
  • Shopping at Home Depot: $60; Cash Back: $0.60 (1% of $60)

The total cash back comes out to $4.07, pretty much the same as Credit Card XYZ that uses a points system.

How Purchases Earn Cash Rewards

There are three main ways that credit cards offer rewards on purchases.

Rotating Categories

In recent years, it's become popular to offer a higher percentage on categories that rotate each quarter. So, for three months, you might get 5% back for groceries, restaurants, and gas (1% on other purchases), but next quarter, it might be something different, like department stores and home improvement stores.

Not only does this make it difficult to really evaluate whether a credit card will be beneficial for you, there are also hoops to jump through in order to get these extra rewards. Many credit card issuers require that you sign up for the higher cash back each quarter. So, if you don't remember to go in and sign up for that 5% cash back on the quarterly category, you'll miss out, even if you spent in those categories.

Tiered Categories

In many cases, depending on your spending habits, you can do better with a tiered category card. These are cards that don't rotate categories. Instead, they offer different cash rewards for different categories. You might receive 3% back on groceries, 2% back on gas, and 1% back on other purchases. If you are willing to pay an annual fee, you might be able to get 6%, 3% and 2% cash rewards in those categories.

If you plan your spending so that you use your card for all of your common expenses, these tiered cards can be more effective than a rotating category card, since the cash back can offset your annual fee, and help you come out ahead. (See also: Top 5 Credit Cards for Groceries)

Flat Rate

Flat rate cash rewards cards are making a bit of comeback right now. These are cards that might offer 2% or 1.5% on all purchases made throughout the year, no matter the category. If you don't use your card often, and you don't like the idea of keeping track of which card to use for different purchases, this type of cash rewards card can make a lot of sense. In many cases, when you average out what you're getting from a rotating category card, you are likely to average out to 1.5% to 2% overall anyway.

Redeeming Your Cash Rewards

Cards offer different options for redeeming your cash rewards. Many issuers have a threshold before you can redeem, so you need to build up your rewards. If your card operates on a points system, you might need to reach a minimum of 1,000 points ($10) for example, before you can cash out.

Here are some of the common ways that you can usually redeem your cash rewards.

Statement Credit

Your cash back is applied to your balance. You can apply the amount to your balance before you make your credit card payment. If you have a points-based rewards card, there will be a system for converting your points to cash. Usually it's a simple process if you access your account online.

Cash or Check

In some cases, you can choose to have cash deposited into the bank account of your choice. Some consumers use this option to boost their emergency savings. You might also be able to receive a paper check that you can deposit wherever you want.

Gift Cards

An increasingly popular way to redeem cash is via gift cards. In some cases, you might be able to redeem cash or points for a gift card with a face value that does more good than a statement credit or cash back. For example, if you have earned $20 in cash back, you might be able to get a $25 gift card to your favorite store. Or you might need 5,000 points for a $50 statement credit, but you might be able to get a $50 gift card for 4,500 points. As long as the store you prefer is available, it can be a better choice to redeem for a discounted gift card.


In some cases, you can convert your cash rewards into merchandise. This is often the least effective way to redeem your rewards, since the value of the merchandise rarely compares to the cash or cash equivalent you receive. With merchandise, there is a good chance that you are basically paying $25 for something that you could buy from the store or online for $15 or $20. It's not usually a good deal.

Important Note on Rewards Caps and Annual Fees

Make sure that you understand all the terms and conditions of your rewards credit card. Don't miss out on getting all the cash back you can by skipping over the fine print.

Reward Caps

Due to the overwhelming popularity of credit card users trying to capitalize on rewards, credit card issuers have started placing caps on the amount of cash back you can earn. For cards with rotating categories, they may have a condition that the cash back bonus rate only applies to the first $1,500 (on all the categories combined). After that, you'd get only 1% back. For tiered categories, there might be an annual limit. Once you hit that, it goes back to the standard 1% cash back until the next year.

Annual Fees

The most attractive cards with the higher rewards are usually cards with an annual fee. Run the numbers to see which card makes sense for you. Even if you think you'll earn back enough to pay for the annual fee, see if choosing the no fee card would get you more cash back.

For example, If you earn $100 a year in cash back, but have to pay $75 for the annual fee, you're getting $25 back per year. It's a net positive, however, you might be able to get $50 back on a no-fee card. Sure your rewards are lower, by half, but you're still ahead because you didn't have to pay the fee. Cards with annual fees only make sense if you can really maximize the bonus categories.

Ready to sign up for a great cash rewards credit card? We've picked out the 5 Best Cash Rewards Credit Cards!

Disclaimer: The responses below are not provided or commissioned by the bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by the bank advertiser. It is not the bank advertiser's responsibility to ensure all posts and/or questions are answered.

Guest's picture

Excellent overview. Rewards credit cards are now the norm because customers expect to get something back for using a particular company credit card.

I myself use a cashback credit card but as you rightly say sometimes it can be more lucrative to opt for other credit cards that offer gift rewards or vouchers that can be many times more than the value of physical cash.

Great analysis :)