The Truth About Credit Card Reward Programs

May 11, 2009 — -- Americans have a long-standing love affair with credit cards and banks have made their cards even more appealing through loyalty reward programs that promise everything from cash back to free flights, as long as you spend a certain amount.

"GMA" financial contributor, Mellody Hobson discusses the diminishing value of these programs and what pitfalls to look out for when choosing a rewards program credit card.

These reward programs have become commonplace in the credit card industry.

According to Affinity Solutions, a company that creates and manages such programs, 40 percent to 45 percent of all existing credit cards are linked to some sort of reward program.

Unfortunately, as with most industries, the credit card industry has been hard hit by the faltering economy.

Why Companies Are Cutting Rewards Values

In order to cut their expenses related to these programs, issuers have taken actions to change the terms of their reward programs.

Changes include increasing spending thresholds for rewards, reducing the points earned for a purchase, increasing the points needed to redeem an award, or shortening point expiration periods. Some examples can be found with the most popular cards:

With the American Express Delta Skymiles card you used to get double miles for shopping in various categories, now you only get the mileage times one.

With the Citi-Premier-Pass you use to get 10,000 points just for signing-up, now you have to spend $300 in the first three months.

The Miles by Discover Card program now requires 10,000 miles for a $100 travel credit, when in the past you could start cashing-in with as little as 5,000 miles for a $50 travel credit.

With all these changes it is no wonder that points have become less valuable. According to Cardratings.com, the average reward point is worth one penny, and in cases where you are exchanging points for items, the amount can be worth even less.

Who Should Stay Away From Rewards Credit Cards

According to the most recent Federal Reserve stats, 46 percent of all American families carry credit card debt.

If you fall into this category, you should definitely consider other credit cards.

First, studies have shown that credit card users with reward programs spend twice as much as credit users without reward programs.

This leads to increasing your debt level.

Differences Between Programs

Credit cards with reward programs average a higher interest rate. Credit card programs with reward programs average a higher interest rate than those without reward programs.

According to Bankrate.com this week, all variable rate credit cards averaged an APR of 10.8 percent, while cash-back cards averaged a rate of 13.9 percent.

So let's say you get 1 percent cash back on all purchases, and you spend $1,000, then you will get back $10. However, if you carry $500 of your purchase as a balance, then the difference in interest between the two cards for a year will be $15.50, so any advantage from the reward will be eliminated.

Who Benefits From These Programs?

Credit card reward programs are best suited towards those people who do not carry a balance, and therefore are not affected by the higher APR.

These people can really rack some major rewards based upon their spending. Secondly, reward programs are good for those consumers that actually spend the points.

According to a Harris Interactive poll, 41 percent of all reward card holders rarely or never use their reward points. Therefore any additional spending you may have incurred to get those airline miles was a waste.

Finding Out What's Right for You

The first step is to go to one of the reputable websites out there that compare different credit card options. Websites such as cardratings.com and bankrate.com make it easy to compare cards across many different dimensions.

Secondly, look for the cards for the lowest APR, especially if you think you are going to carry a balance. Next, try to get a card with cash back rewards. The rules for earning and redeeming cash rewards are usually much simpler than those for redeeming merchandise or airlines.

Avoiding Credit Card Rewards Program Pitfalls

Additionally, many rewards require you to spend more than the item is worth. For example, a $300 camera may actually cost you $400 in points.

Many airline miles programs have blackout dates or allocate very few seats to free flyers (only 6 percent of all seats by some estimates), which virtually make your miles unusable.

Finally, try to choose a card that most perfectly fits your lifestyle. For example, if you drive a lot than a gas card that rewards you with 5 percent back on all gas purchases may be a smart move.

Before you sign-up for any credit cards, especially those with reward programs, you should always read the fine print. Some cards require a minimum amount of spending a month in order to qualify for rewards.

Some low minimum reward levels may only be good for the first year of the program, so make sure you know what you are getting into.

Also remember that credit card companies can change terms of a reward program at any time, so try to check the rules of your reward program throughout the year. Second, make sure you stick to your budget and avoid purchases just to earn points.

Third, do not be tempted by cards who offer to give your rewards to charities. According to consumer reports they usually only give 25-50 cents for every $100 that you spend, and you cannot write-off the donation. You are better off just taking a cash back reward from another card, and donating the money yourself.

Finally, try to avoid cards with annual fees; they will only eat into your total reward. Approximately 20 percent of all reward cards have annual fees, so you should be able to find great cards that do not have a fee.

Mellody Hobson, president of Ariel Investments in Chicago, is "Good Morning America's" personal finance expert. Click here to visit her Web site, www.arielinvestments.com. Amar Parikh contributed to this report.