Cash-Back Cards Often Cause More Spending, Higher Debt

Published February 21, 2011

Those cash-back credit cards that look like such a good deal tend to encourage users to acquire more debt, which results in no net benefit to them, according to researchers at the Federal Reserve Bank of Chicago.

On average, a 1 percent cash-back rewards program earns the cardholder $25 in cash, the study found. However, the same cardholder increased spending on that card by $76 a month and raised the amount of debt carried each month by $197. So most rewards programs cost people more money than they get back.

“The impact of a relatively small reward generates large spending and debt accumulation,” the study concluded.

Small Rewards, Greater Use
Credit card companies have long enticed users with rewards programs, from airplane miles to hotel rooms and cash back. Even small rewards can prompt people to spend more. In many cases, rewards entice people whose cards were dormant to start spending, the study found.

About 11 percent of those who hadn’t used their credit cards in the previous three months made purchases of at least $50 in the first month of the program.

Three Federal Reserve economists looked at 12,000 credit card accounts at an undisclosed financial institution. Some of the customers were offered cash-back rewards, others were not.

Faster Debt Growth
That debts grew faster than spending among those offered cash rewards likely means people reduced their monthly payments more than they increased spending, according to the researchers.

The extra debt could mean two things: People spent more overall or they shifted spending to their cash-back rewards card from some other card. Sumit Agarwal, one of the coauthors, says the study found both.

“The right thing for people to do is to move all of their debt and spending from some other card, but we actually see them taking on additional debt,” he said.

Agarwal and his coauthors, Sujit Chakravorti and Anna Lunn, also found reducing the interest rate on credit-card balances prompts consumers to increase their spending on the card. But the data suggest “many cardholders transferred balances or spending from other credit cards”—presumably higher-interest-rate cards—”to this one at the beginning of the promotion.”

At first, consumers often feel they can benefit from the cash-back program, but then they let their spending get out of hand, said Bill Hardekopf, CEO of and author of The Credit Card Guidebook.

“They have the mentality that they are making money with this, then they wind up spending more than they can cover the following month [before interest charges start],” he said.

Cash-Back Spending
The cash-back feature also prompts consumers to spend more than they would on cards with other rewards programs, Hardekopf said, because it’s much easier to redeem the cash quickly, whereas the mileage rewards need to build up for a long time before someone can “earn” a free flight.

“Consumers always get these cards because they start with good intentions to have something help them get a bit more ahead,” said Julie Murphy Casserly, a Chicago-based certified financial planner and author of The Emotion Behind Money. “In reality what happens is that it creates more financial drama in their lives. People emotionally spend differently when they are handing over cash. They’re more conscious of spending than when sliding a credit card.

“The general public justifies to themselves that it’s OK to spend more because of the rewards,” she added. “What happens in the end, they get farther and farther from the financial reality they truly want to create.”

Carrie Coghill, director of consumer education for in Norwalk, Connecticut, agrees.

“When people take on these cards, it’s not so much that they are doing it so they can reduce their debt or interest expense,” she said. “It’s more that they can spend more and it won’t cost so much [net of the cash rewards]. When you are doing something you think is really good, you don’t want to take the time to understand the dynamics of some of the drawbacks.”

The credit card issuers have recognized the success of the cash-back programs and have been leading with these offers with their recent increases in credit card solicitations, Hardekopf said.

Phil Britt ([email protected]) writes from South Holland, Illinois.