What Is a Rewards Card?

By Markets Fool.com

Does your credit card give you something back each time the cash register rings? More than half of cards issued have a rewards component, offering everything from cash back and free airfare to charitable donations and contributions to Junior's college fund.

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If you're going to put your purchases on plastic anyway, consider using a card that rewards your loyalty.

How rewards cards work
Rewards cards can be tied to a specific retailer, airline, or hotel chain. They can also be general-use cards issued by a major credit card company or bank.

The mechanics of how these cards work are pretty straightforward:

  1. Sign up for a card.
  2. Use the card to pay for stuff, racking up rewards all the while (more on that in a moment).
  3. Redeem your earned bounty.

You're a good rewards card candidate if...
Going from frequent buyer to frequent flier requires planning and discipline. A rewards card may be good for you if:

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  • You put a lot of your spending on plastic. If you're someone who prefers plastic over paper (cash), then you're a good candidate for a rewards card. After all, the key to cashing in is earning points, and the main way to do that is to use your card.
  • You pay off your balances in full every month. The best thing about rewards cards is, well, the rewards you can earn. Because it costs card companies more money to run these programs, they make it up in other ways. That's why interest rates on rewards cards tend to be higher than those on standard-issue credit cards. If you carry a balance -- even just occasionally -- paying interest essentially wipes out the value of any rewards you've racked up.
  • You have the willpower to avoid over-spending."I'm getting points/cash/miles for this!" That's the worst excuse for filling up your shopping cart with stuff you don't need. It's never worth it to spend money simply to "earn" points or other rewards.
  • You have decent credit. Credit cards with bells and whistles often have higher standards for applicants. Those with less-than-stellar credit often don't qualify for the cards with the best perks, or they only qualify for rewards cards that carry steep annual fees.

Kinds of rewards cards
The rewards card category has exploded in recent years. The key is to pick the one that offers rewards you'll actually use. Most cards fall under the following categories.

Cash-back cards: Within this category are several types of cash-back cards. Fixed-value (also called flat-rate) cards follow a fixed formula for generating your rewards. For every dollar you spend, you get a set number of points per percentage back -- typically 1 to 2 points, which is worth $0.01 to $0.02 per dollar spent.

Other programs are more involved. Some cash-back programs offer tiered rewards based on the amount you spend. So, as your spending grows, so does the amount you get back in cash. Some programs have rotating categories of rewards. For example, you may be rewarded at a higher rate when you shop at certain stores or during certain time periods, or when you buy certain products (e.g., groceries, gas, restaurants, entertainment, etc.).

Best for: Who doesn't like cash? It's accepted almost everywhere, unlike points or company-specific rewards. For simplicity's sake, you almost can't go wrong by choosing a cash-back rewards card.

Air miles/travel cards: Airlines and hotels offer their own branded cards, with spending dollars tallied and turned into points good for discounts on airfare and hotel stays. Often, you'll find these types of cards emblazoned with a few corporate names, especially when these companies team up to create co-branded cards. The point values on air/travel cards often exceed the typical $0.01 to $0.03 per dollar spent, especially when the card is used at specific companies included in the loyalty program.

Best for: If you're a frequent traveler -- and especially if you tend to frequent the same airlines and hotels -- you can build up some serious rewards by concentrating your spending on a miles or travel card. Many even come with additional perks, such as priority boarding, free bag-checking, and a pass to the fancy members-only airport lounge.

Retail rewards cards: Major retailers often offer co-branded rewards cards with perks that are tailored to their customers. These credit cards offer rewards for spending anywhere, but the high-value perks come when you use the card to buy their wares and services. The rewards you earn may be limited to discounts and freebies at that particular retailer. Also falling under this category are gas cards that can either be company-specific or general. These can also offer general rewards on all purchases, and they may up the rewards ante when you fill up at a station run by that particular company.

Best for: If you have a go-to retailer for much of your household spending, consider cozying up to a company-specific card. Or perhaps you have a one-time project coming up, and you know you'll be dropping some serious bank at a particular home improvement store. Check to see whether it has a loyalty program and/or offers a co-branded card with perks that will help you cut costs.

Reward card caveats
Remember, a rewards card is still a credit card; the same rules of engagement still apply. To remain in good standing with the card company, you must pay your bills on time (and, we recommend, in full), stay well within your credit limits, read the fine print, only spend what you can afford to pay for in cash, and refrain from using the card to pick food out of your teeth in public. Also watch out for:

  • Annual fees: There are plenty of cards that don't charge one; however, those that do may offer more valuable perks than the no-fee version. Do the math.
  • Higher-than-average interest rates: Rewards cards often come with higher interest rates, so they're not the smartest choice for those who carry a balance. Make sure you're the one who's being rewarded -- not the credit card company.
  • Rewards caps: Look for conditions on the amount of money you can earn. Some cards impose an annual limit or place caps on earning potential on particular spending categories.
  • So-called "sign-up bonuses": The offer says in big type that you'll get 25,000 points when you sign up for the card. That's not always true. Redeeming those points may require you to spend a certain amount on the credit card within a certain time period.
  • Expiration dates: If you're earning points or air miles, find out (from both the card company and the airline) how long they're good for and what you have to do to keep your points in play. Also, before canceling the card, check to see whether doing so will forfeit your rewards.

The bottom line
A rewards card can make a nice addition to your wallet -- and your bottom line -- but only if you use it responsibly (i.e., don't spend recklessly just to earn a free golf bag or a few extra airline miles) and if the card offers rewards you will actually use.

The article What Is a Rewards Card? originally appeared on Fool.com.

Dayana Yochim has no position in any stocks mentioned. The Motley Fool recommends American Express. The Motley Fool owns shares of Capital One Financial. and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.