5 Things to Know About Cash-Back Credit Cards

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The best cash-back card offers promise unlimited rewards that equate to money back on every purchase you make. Over time, these rebates can add up to hundreds or thousands of dollars in value, even with some no-annual-fee cards, but there are a few things you should know before applying for a cash-back rewards card.

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1. Bonus categories aren't always worth it

Thanks to the enormous popularity of cash-back cards, there is now a huge variety of rewards structures that incentivize certain types of spending. Many cards offer higher cash-back rates on purchases made at gas stations, restaurants, and grocery stores, for example.

The truth is, though, that it's easy to perceive these perks as being more valuable than they really are. The average household doesn't necessarily spend that much on these major bonus categories, according to data from the Bureau of Labor Statistics.

Budget Item

Average Household Spending in 2015

Food at home (grocery)

$4,015

Food away from home (restaurants)

$3,008

Gasoline and motor oil

$2,090

Take gas cards, for instance. While 3% cash back on gasoline purchases may sound like a sweet deal, it may have little to no advantage over a card that offers a flat 2% cash back on all purchases. Say your card pays you 3% on gas purchases and 1% on the other two categories above. Assuming you spend the average amount on each category and charge it all on that card, you'll get about $133 back for the year. Meanwhile, a card that pays you 2% of every purchase would return $273 to your wallet -- and that $140 difference would grow if you used the card for more types of spending.

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Of course, people spend different amounts of money on different things. Large families with kids can crush it with a cash-back card that incentivizes gas and wholesale club purchases, while a young-adult household might fare better with a simple flat-rate cash-back card for all spending.

2. Minimum redemptions matter

Be aware of a cash-back card's minimum redemption threshold -- i.e., the smallest amount in rewards you can claim. Typically, cards have minimum redemption amounts ranging from $0 (no minimum) all the way up to $100. At the high end, cardholders may have to wait months or years before meeting the minimum redemption threshold.

For this reason, smaller spenders may want to stick with a card that offers flat 1.5% cash back with no minimum redemption, rather than applying for a 2% cash-back card that has a $25 or $50 minimum redemption threshold. Rewards that sit unused, or are never redeemed, simply have no value.

3. Travel cards can be a better value

If you don't have much use for free hotel stays, flights, or rental cars, you can skip this section. But if you do travel, know that a travel card may be a better value than a cash-back rewards card.

It's an unwritten rule that travel cards have some of the most lucrative sign-up bonuses, and the points (or miles) they earn can have value in excess of their stated value. Last year, I used points that the card issuer valued at $1,500 to stay in a hotel that would have cost me $2,800 for the duration of my stay.

Many travel cards offer the ability to transfer points or miles to hotel and airline loyalty programs, which can amplify their value. Although my points had a stated value of $0.015 each, I effectively redeemed them at a value of $0.028 each -- nearly twice the value advertised by the credit card issuer.

This isn't unusual, nor did it require any extra knowledge or trickery on my part. All I had to do was transfer my points from my credit card to a hotel loyalty program to get value beyond the advertised value. That said, if you don't travel, a cash-back card is almost universally a better pick, as travel card rewards usually redeem for cash at a lower rate. 

4. Sign-up bonuses are where the money is

Don't make the mistake of ignoring sign-up bonuses when applying for a credit card. Frequently, cards that have a lower cash-back rate of 1.5% are better than a card with a 2% cash back rate when the new-cardholder bonus is taken into consideration.

Many of Fool.com's top picks in cash-back cards offer a sign-up bonus of $150 or more for as little as $500 or $1,000 of spending. In fact, our top three picks all offer at least $150 in new-cardholder bonuses for qualifying cardholders who spend $1,000 or less in the first three months after account opening.

When combined, these cards collectively reward qualifying cardholders with $500 of sign-up bonus rewards just for spending a total of $2,000. That's like getting an average of 25% cash back on your purchases during the promo period.

5. If you carry a balance, then forget it

Cash-back rewards can be lucrative, but they have no value for people who carry a balance on their credit cards. Paying just three months' worth of interest erases all the benefit of an enormous 5% cash-back rate earned from a bonus-category credit card.

Cardholders who carry balances should instead look into 0% APR promos on balance transfer credit cards. Balance transfer cards are widely underrated. Moving a $5,000 balance from a card at an 18% APR to a 0% balance transfer card can save you more than $600 in interest during the introductory period. You'd have to spend $30,000 to $40,000 on the best cash-back cards to generate that kind of value!

For people who have balances, the value provided by 0% APR balance transfers easily exceeds even the most lucrative rewards cards

It pays to consider all your options before sending in your application. Cash-back credit card rewards aren't the only way to extract value from credit cards. Zero-percent promo APRs can go a long way, too. 

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