Does Earning Credit Card Rewards Take Advantage of Other Consumers?

I don’t ever want you to pay interest on a credit card. Or at a minimum if you wind up having to then you shouldn’t be deciding which card to use based on rewards. There are a handful of good 0% balance transfer cards that also do not charge a balance transfer fee. That’s crucial, because plenty of cards offer 0% balance transfers but hit you with a fee of 3% of the balance you transfer.

I don’t think interest, or credit card interest is evil. I believe that consumers generally understand the choices they’re making, even if you or I might make different choices. And people do need credit. If you didn’t have credit cards, the need for credit would still be there, and consumers would be left with the next best option.

One of my favorite pieces in The Onion was “Mom-And-Pop Loan Sharks Being Driven Out By Big Credit-Card Companies.”

Frank Pistone is part of the dying breed known as the American Loan Shark. Not so long ago, the loan shark flourished, offering short-term, high-interest loans to desperate people with nowhere else to turn. Today, however, Pistone and countless others like him are being squeezed out by the major credit-card companies, which can offer money to the down-and-out at lower rates of interest and without the threat of bodily harm.

“It’s a damn shame,” said Joseph Stasi, 61, a South Philadelphia loan shark whose business is down 90 percent from its mid-’70s heyday. “These days, there’s just no place for the small businessman. My kind, we just can’t compete with the Visas and MasterCards of the world.”

If you need to fix a car to get to work, or pay a medical bill, credit cards are a better way to do that than payday loans which are better than having your legs broken. You’re paying interest, but you’re also getting something of value in return.

Ryan points me to someone who seems to want you to think that people paying interest are victims — not of the banks, but of you and me.

People use the word subsidy without really understanding it. Banks aren’t charging more to customers who revolve in order to pay rewards to customers who don’t.

Banks make money in two ways off of credit cards:

  • Interchange or merchant swipe fees, this is the 2%+ that businesses pay to accept credit cards. The fees for rewards cards are more expensive than non-rewards cards, and super premium rewards cards (like Visa Infinite, World Elite Mastercard) more expensive still. Of course those customers also spend more than others, too.

  • Revolve or interest customers pay on balances that aren’t covered in full at the end of each month.

For 99%+ of rewards cards rewards expense is lower than interchange (merchant swipe fees). Sometimes banks bet wrong and spend too much (which is why they then take half a billion dollar charges to their bottom line). The only place where customers paying interest alone seems like the only way a bank could make money and that they believed this up front has to be the Citibank-Costco deal.

There’s no question that when you use a credit card that earns the highest level of rewards and you pay your card off in full each month you’re coming out ahead. And there’s no question that makes you not the bank’s most profitable customers. That doesn’t mean there is a transfer of wealth from customers paying interest to those who don’t.

  • There is a transfer of wealth from customers who pay interest to banks

  • Acquiring lots of customers helps the bank find both moderately profitable customers and highly profitable customers

  • Rewards card customers spend much more than customers with non-rewards earning cards. They’re also good customers for cross-selling.

Without the business of high spending customers who do not revolve banks wouldn’t have enough volume to offer their co-brand rewards partners like United, American, Delta, Marriott and Costco in order to win that business.

If we adopt the definition of ‘subsidy’ used to argue that customers paying interest are subsidizing those who don’t, then it’s equally fair to say that customers not paying interest are necessary to make the card products possible in the first place and are thus ‘subsidizing’ those that pay interest.

Of course that’s not what’s happening. Banks need both kinds of customers. Both kinds of customers get value out of their credit card relationships. Although savvy consumers should always try to get as much value as possible, no matter which kind of customer they’re going to be.

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community InsideFlyer.com, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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Comments

  1. Also to note there should be very few write offs from those that chase rewards as these customers are not seeking the credit as much as they are seeking the rewards, so we are not part of the bank’s losses on the credit side.

  2. That dude is an idiot. Do not pay attention to idiots.

    Life is too short and there is no end to the supply.

  3. @ Gary — Does being smarter than others take advantage of their stupidity? Yes, although DJT has figured out how to flip this on its head. Sadly, the vote of a moron = the vote of a genius. We really should require voters to pass an IQ test first.

  4. How so?

    All consumers have the same shot subject to limitations (5/24 and such) and credit score. Some take advantage (which is totally legit) and some don’t. This is like clipping coupons, some people do it, and others don’t. Credit cards have already allocated budgets for loyalty programs and in fact most programs make money as recently reveled by one of the bloggers.

  5. Interest is charged for 3 reasons: It provides incentive for investors to save money in banks and allow the banks to loan that money to others. It provides the banking industry the incentive to develop and maintain the infrastructure necessary to provide both temporary float capital to millions of consumers, as well as impromptu mid-term length loans to many of those same consumers whenever they are needed. It also provides insurance against the risk of consumers defaulting on credit card balances.

    Interest is not used to cover the expense of rewards used by other customers. Rewards and interest are both incentives to attract two different types of customers to the same product. Otherwise, charge cards that offer rewards wouldn’t be a thing.

  6. When I clicked I thought you might discuss another aspect–at the retailer: What about people paying cash vs. paying with a rewards card at the same business? Do we cause higher prices for cash-only customers?

  7. Ya know… I just assume someone trying to change my behavior is trying to profit from it, or trying to aid someone else in the profit from my changed behavior. Me, I’d prefer to keep as much profits for myself as a I reasonably can.

    As a free markets guy, I figure that the banks are extracting as much profit as they possibly can from each individual person they are doing business with. It means that for each transaction, they are charging “what the market will bear”. Is there any real reason to believe that if the banks stopped offering rewards cards, that they’d lower the interest rate for those who carry a balance? What sense does that make? And while in theory the banks could raise interest rates sky high if they wanted to, at the very least, people would default and the debt would get charged off.

    So no. The dude is either an idiot or wants to make money off of me somehow.

  8. What about the argument that cash customers (more likely to be poor) are providing a subsidy for us fancy folks by way of higher prices to absorb these fees. Most businesses don’t charge differentially for credit. That’s a fair claim.

  9. @Rocky

    What about the argument? It sucks to be poor, no doubt. I once had bad credit and sometimes had trouble getting credit at all, and I hated it. So I stopped having bad credit and life got much better. And now the banks give me the ability to fly all over the world for next to nothing.

  10. It seems like you’re only looking at customers within-card rather than within-bank. Obviously a CSR attracts a different segment than a no-frills no annual-fee card with relatively-low interest. And although each card should ideally be profitable in a vacuum, do you really believe that the interest paid off of the ~1trillion in credit card debt doesn’t allow the banks to offer higher rewards to those making money on swipes rather than interest?

  11. There is another way to look at this question. That is: Do those who MS take advantage of those of us who generate our miles/points legitimately–the way credit card companies assume we should be earning miles/points? In my opinion, the answer is “Yes.” Those who MS take real advantage of all of us using credit cards. What they do is not illegal, but it is dishonest and the rest of us pay.

  12. Ok what about the fact that credit card rewards can open up aspirational rewards to people who would otherwise never have been able to afford them? Like poor people for example. It may take them longer to get there but they can still do it.

  13. I’ve misused credit in the past, and I paid some heavy penalties for my foolishness. I wasn’t being taken advantage of, I was being stupid.
    I’m no longer careless with credit and use my credit wisely, including enjoying rewards flights and hotel stays through bonuses and points earning. If you’re going to use credit of any kind, you need to get educated on the realities.

  14. Yeah, those who know what they’re doing are not required to modify their behavior to accommodate the idiots of the world.

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