How do cash-back credit cards work, and are they worth it?

Credit cards can be powerful personal finance tools when used correctly. For example, you can earn cashback on your purchases at certain retailers. Over time, these valuable credit card rewards add up, and you can use them to get free products, gift cards, and even cash rewards sent right to your bank account.

You may wonder, “How do cash-back credit cards work, and how can I make the most of them?” We cover all that and more below.

What is cash back?

Cash back literally means you receive money back for using your credit card at certain retailers. This cash reward can come as a statement credit, a check in the mail, a direct deposit into your bank account, or even a gift card. However, throughout the years, cash back has become more of a catch-all term for any rewards a credit card offers.

Other types of cash-back rewards can include things like:

• Points toward travel or hotel stays

• Points toward purchases online

• Free gifts

• Special discounts at certain stores

Basically, any rewards you earn from using your credit card can fall into that “cash back” bucket. These cards are often referred to as cash-back credit cards or rewards credit cards.

How do cash-back credit cards work?

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Cash-back credit cards are like any other credit card. You swipe them at a store when you want to make a purchase. Then, the credit card company sends you a monthly statement that outlines all the charges you made, any interest you’ve incurred, your minimum monthly payment, and in many cases, the amount of cash back rewards you’ve earned.

While their function is the same as a normal credit card, rewards credit cards work differently behind the scenes, impacting your spending habits. Let’s check out how this all works.

How do you earn cash-back rewards?

Credit card companies will usually offer cash-back rewards in one of two ways: percent of purchase or points per dollar. Let’s check them out.

Percent of purchase

With this type of cash back, you make a purchase, and the credit card company will offer you a reward worth a set percentage of that purchase. For example, let’s say your credit card offers 1% cash back on all purchases. If you spend $100, you’d get a $1 reward.

Sometimes this type of rewards program will offer bonus cash based on the type of retailer you shop at. For example, you may get 2% on all eligible purchases, but the credit card company may offer 5% rewards at grocery stores or gas stations. So, if you spent $15 on fast food, you’d earn 2% in cash back (or 15 cents). But if you spent $100 at a supermarket, you’d earn 5% in cash back (or $5). 

While credit card rewards and bonus cash offers might be the same each month, some credit card companies have rotating categories. For example, a company may offer 2% on most purchases, but then change which category earns a 5% cash back rate. 

This may change each quarter or each billing cycle. For example, you might earn 5% at department stores during one billing cycle and 5% at grocery stores during the next cycle. They generally call this bonus cash or bonus rewards in the category they raise.

Points per dollar spent

With this rewards model, you will earn points for each dollar spent and can then redeem those points for rewards, like gift cards or travel vouchers. For example, you may earn one point for every dollar you charge to your card. 

But similar to the percent-of-purchase rewards, a credit card company may have bonus categories that earn more. So you might earn five points per dollar spent at drug stores, two points per dollar spent at grocery stores, and one point per dollar on all other purchases. 

This type of cash back system can also have rotating spending categories or bonus categories.

Some credit card companies may also offer sign-up bonus points for new cardholders who spend a certain amount within an intro period, such as 10,000 points for spending $3,000 within the first three months of having the card.

What are eligible purchases?

In your credit card terms, you will see that you only earn rewards on “eligible card purchases.” But what does that mean? This typically means any retail purchase at a merchant, organization, or business that accepts the credit card you used.

This does not include balance transfers, cash advances, ATM withdrawals, or other types of cash-like transactions.

How do you redeem your cash-back rewards?

How you redeem your credit card cash back can vary between credit card issuers. Most, however, will have an online portal where you can redeem your points or cash back. Generally, your cash-back credit cards will have a variety of redemption options. For example, you might be able to buy gift cards, get a statement credit, receive a bank transfer, or purchase products.

Travel credit cards that focus mostly on travel rewards usually have redemption sites similar to popular travel sites, such as Priceline, KAYAK, or various airlines. In this interface, you can choose the date you need to travel or want accommodations and the city or cities you plan to visit. The system then shows you its offers and the points they cost. You may even be able to pay partially in points or cash back and the rest in cash through a bank account or debit card.

Are cash-back credit card accounts worth it?

Whether a cash-back card is worth it depends on how you use it. As of April 3, 2023, the average credit card interest rate is sitting at 24.20%. That means just one month’s worth of interest can offset multiple months of collecting rewards. 

So is there a way to reap the rewards of a credit card without the interest charges? Yes, there is. If you pay off the balance on your credit bill each month by the due date, you’ll be able to avoid interest charges but still earn cash back or points.

What should you watch out for when considering a cash-back credit card?

You have no shortage of cash-back credit cards to pick from, but not all are created equal. Watch out for these potential traps to find the best cash-back credit cards.

Annual fee

Annual fees vary greatly and can reach hundreds of dollars. While an annual fee doesn’t mean you should toss out a cash-back credit card, it does mean you need to do more research.

Look at the rewards and other perks the card offers and compare the value of these rewards relative to the annual fee. It may be worthwhile if that annual fee is less than the value of the perks and rewards. You’ll want to skip the card if the rewards and points are worth less than the annual fee.

Other fees

Other fees to consider when looking at a rewards credit card include foreign transaction fees, cash advance fees, and balance transfer fees. If you plan to use the credit card in a manner that will result in you getting hit with these fees, compare them to the potential rewards you’ll earn. You may want to find a different card if the rewards are less valuable than the potential fees.

Rewards categories

It’s wise to examine the rewards categories closely and the amount of rewards the credit card offers. If the rewards aren’t from places you shop, then the credit card is not worthwhile for you. Search for a card that has rewards points categories and stores you regularly shop in. This applies to rotating categories and flat-rate cash-back cards — those with one rewards rate for all purchase categories.

Cash back credit cards can be good personal finance tools

Now that you know how cash back credit cards work, you can see how they can be valuable personal finance tools when used correctly. Look for a card with great rewards at places you shop regularly and pay off your balance in full by the due date. With this strategy, you can earn freebies without paying any interest. It’s a win-win.

Visit Greenlight’s blog to learn more about credit — from rewards to credit scores, and more.