January 15 2011|02.01 PM UTC

Samantha Eckles

Rewards: When to Use Credit Vs. Debit

Category: Credit, SR

Both credit and debit cards offer various types of benefits. Credit allows us to use money we don’t have on hand; debit cards are like cash, but more convenient.

I often use my credit card instead of cash or a debit card (even when I have available funds) because I love accruing credit card rewards. I store them all up and then fly to Europe when I have enough miles for a free ticket.

It has been a good trade-off thus far: my issuer made some interest off of my monthly purchases before and in turn, I get to eat croissants in Paris.

But, before we dream of hoarding miles, consider the real facts: If you can’t pay off your credit card balance every month, there is no existing reward that will sufficiently compensate you for the money you will end up paying in interest. Since credit card interest rates can easily reach 23.99% (the average, according to FICO.com), every dollar you carry in your balance can mean far more in monthly payments.

Plus, all those juicy perks that have lured us to use plastic might only get us a free ticket to Peoria, not Paris, these days.

The impact from recent legislation (see CARD Act and Durbin Amendment) has reduced the ability of banks and other issuers to be as profitable as before and many of the reward programs are being eliminated.

Credit cards generally bring in $0.65 in reward value per $100 of spending while debit cards only bring in $0.10, according to Consumer Reports. That reward money has to come from somewhere and one of the most major sources of that revenue has largely dried up. Ever since the CARD Act forbade card issuers from doing such things as switching payments dates without notice (which garnered a great deal of interest income) and ratcheting up cardholders’ interest rates, the profit margins of many financial institutions have been greatly reduced.

Good credit card reward programs are still out there, but you may have to hunt around a bit more to find them. BillShrink’s free credit card search tool helps you quickly shop around for cards with the best perks.

Debit Card Reward Programs Are Also Under Threat

Banks used to help pay for rewards programs with debit fees. All the times we swipe debit cards, banks get paid fees that total more than $20 billion a year. In July 2011, the Federal Reserve will start regulating these swipe, or interchange, fees in an effort to create more competition among card networks (currently Visa and MasterCard hold 80% of this market) and bring down some of the fees that merchants and consumers have been covering. Banks have to change their business models to make up for the lost fees. Bank of America, for example, expects this regulation called the Durbin Amendment to cut 60–80% of its $2.9 billion debit card fee business.

The results are a trimming down of debit card rewards programs and a readiness for innovative business models so that banks can avoid charging customers for the maintenance of their accounts. It’s awesome if you’ve already enrolled in a rewards program like Citi’s Thank You Network or Bank of America’s Keep the Change — just be prepared for your rewards program to change. Chase, which has a number of debit rewards programs, stopped giving bonuses to bankers and branch managers for signing up debit card customers in October 2010. The financial institution plans to eventually phase out its debit rewards programs and others will probably follow suit (American Banker).

A new generation of rewards will likely emerge, perhaps one that will team up financial institutions with merchants to get creative with the types of rewards consumers will receive. Financial institutions will also want to take advantage of technology that makes online banking and evaluating transactions easier; this way, they can better cater to the personalized needs of their customers.

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