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What is a Rewards Credit Card?

Rewards credit cards are hot: a recent Experian survey found 45% of Americans who plan to apply for new credit cards are doing so because they want rewards cards. But with hundreds of options available, which card makes the most sense for you? And how can you avoid the risks that inevitably come with the rewards?

If you choose carefully and take care to avoid potential pitfalls, you can benefit greatly from rewards credit cards, and even use them to help improve your credit scores.

How Rewards Cards Work

Rewards credit cards offer one or more incentives for frequent use: When you use a rewards card to make purchases, you accumulate credits in proportion to the amount you spend.

Ideally, this is a win-win for you and the card issuer. The issuer wants you to get in the habit of pulling its card from your wallet before any other card (and maybe start using it for transactions where you might normally use a debit card). To encourage you to do so, the issuer provides you with incentive credits, which take a variety of forms:

Cash-Back

The most popular rewards cards offer a rebate—typically a credit to your account at the end of the year—proportional to the amount of purchases made with the card. The most common cash-back amount is 1%—a penny back for every dollar you spend—but 1.5% cards are gaining popularity, and “luxury rewards” cards, with high borrowing limits and offered to individuals with excellent credit scores, offer rebates as high as 2%.

Travel Miles

Cards affiliated with airlines can award anywhere from one-to-two flight miles for every dollar spent (1.25 miles-per-dollar and 1.5 miles per dollar are increasingly common). Awards may be higher when the card is used to purchase airline tickets—with the card’s affiliated airline and, sometimes, even with other carriers. Mileage cards are very popular with business travelers, who use their cards to book reimbursable work trips, and then keep bonus miles for personal use. Some cards require bonus miles to be redeemed only with the affiliate airline; others let you fly with any carrier. Redemption of bonus miles may be subject to blackout dates or other exceptions, as detailed in the cardholder agreement.

Purchase Points

Sometimes referred using terms such as “bonus dollars,” are calculated the same way as cash-back rewards and bonus miles—typically a point for each dollar spent on the card—but they must be redeemed for items or services from a catalog specific to that card. Points customarily accumulate in real time—you don’t have to wait until the end of the year to collect or use them—but they also may have expiration dates before which you must use them or lose them. Depending on the card, points may be redeemed for gift items, merchandise at affiliated retailer(s), stays at hotels, theme parks, or resort properties, or magazine subscriptions (a classic way to “burn off” leftover points before they expire).

Bonuses

Many cards offer special rewards bonuses on specific types of purchases. For example, some cards double or triple the number of credits you receive for booking flights directly through the airline, buying gasoline, or shopping at specific retailers.

Other cards may increase the bonus percentage on specific purchases, such as a card with a standard 1% rewards rate offering a 5% reward on flight purchases.

An increasingly popular approach is “rotating rewards,” which provides deals on certain purchases every 90 days or so. You might get double rewards for instance, on gasoline purchases made during the summer, and on movie tickets purchased in the winter. Sometimes these rewards are limited to specific retailers or vendors, other times they’re more open-ended—but they only last a limited time, after which a new set of deals is made available. Details on how these deals work, and when they begin and end, are provided with card statements and on the card’s website.

Making the most of rotating rewards takes some focus and discipline. Savvy users have developed techniques from web-calendar notifications to cell phone alarms to sticky notes as reminders of the special deals available. Smartphone apps provided by many card issuers can also help you take full advantage of these deals.

Find the Card That’s Right for You

The best approach to choosing a rewards card is to try to find one that gives the best value based on your normal spending habits. Look for a card that rewards what you already do, as opposed to one that’ll make you increase your spending amounts or frequency in pursuit of points.

Chances are good some of the rewards offers you’re receiving already line up with this approach: retailers where you shop often, hotels you frequent, and travel services you use regularly are likely already sending offers your way. You can look for additional offerings using the Experian rewards card finder tool.

Once you’ve narrowed the field to a short list, read the cardholder agreements that come with the cards. Use them to familiarize yourself with the specifics of its rewards program. Don’t forget to compare cards’ fees and annual percentage rates (APRs) as well. Rewards are great, but a lower APR can mean big savings as well over the life of a card.

Get the Most from Your Card

The popularity of rewards cards has spawned a cottage industry in blogs and other websites dedicated to maximizing the accumulation of miles and points. For those with less time or dedication, the key to a good rewards-card experience lies in taking advantage of the bonuses while avoiding potential problems. Here are some guidelines that apply to any rewards card:

Don’t Get in over Your Head

The biggest potential risk connected with rewards cards may be the tendency to make extra purchases in order to gain extra points. Take care not to get spread too thin in your zeal for rewards. Switching to a rewards card for purchases you’d normally make with a debit card, such as groceries or fuel, is fine as long as you plan to pay off those purchases in full each month. But “big-ticket” buys that push your rewards level to new heights could end up costing you in the long run if they lead to outstanding balances and interest charges on the purchases.

Synchronize Activation Bonuses with Major Purchases

Many rewards cards offer a substantial number of points or miles (10,000, 20,000 or even 50,000) as an introductory bonus when you open your account, but only if you charge a minimum amount ($3,000, $5,000, $9,000) within the first three months of signing up. A little planning ahead can help you make good use of these deals, without getting overextended: Apply for your rewards card three or four months before you plan to make a major purchase you’ve already saved for (booking a vacation, say, or buying furniture or appliances). Put the purchase on your new card, and then pay it off with savings to help earn the intro bonus without incurring finance charges.

Look for No-Fee Cards

Many rewards cards come with annual fees. A typical sum is $95, though some are less, and others several times more. Card issuers often waive the fee for the first year, which makes it easy to overlook, but don’t ignore it. At a cash-back rate of 1%, it’ll take $9,500 in purchases just to cover a $95 annual fee, so make sure you don’t end up having to spend more cash than you get back. (Calculating the break-even point on mileage and points cards is trickier, but the same logic applies). And if your strategy is to pay the card off in full then cancel it before the annual fee kicks in, think again: Closing card accounts reduces your total available credit—a factor that can lower your credit scores. That doesn’t mean you should never close an account, but your best bet, if possible, is to stick to no-fee cards.

Be careful applying for cards in succession. When you apply for a new credit card, the card issuer typically requests your credit report—a process known as making a hard inquiry. A hard inquiry usually causes your credit scores to drop slightly. When a lender accepts your application and you open a new credit account, your scores typically dip a bit more. As you long as you keep up with your payments, the scores typically rebound within a few months, and they may even increase somewhat, in recognition that you’re successfully managing additional credit. Make sure you give your scores time to bounce back between card applications because if you apply during one of those temporary score-reduction periods, you’ll be offered less attractive borrowing terms than you’ll get when your scores are at their maximum.

If you invest a little time and research before you sign on, and choose a rewards card that suits your budget and spending habits, you can find a rewards credit card that helps you do more of what you like to do for less money. That’s a real bonus.

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