Cash-back debit cards are becoming more common, but are they a good deal? Maybe -- as long as fees and restrictions don't bite into your earnings.

A small but growing segment of the debit card business, cash-back debit cards are enticing because of the lure of "free" money being put back in your bank account. But the devil is in the details. That cash can vanish if you fail to understand the myriad tricks and traps looming in the fine print.

"You have to pay somewhere. There's no such thing as a free lunch," says John Fisher, president and CEO of Take Charge America, a Phoenix-based nonprofit credit-counseling firm.

Still, if you navigate those obstacles well, cash-back debit cards might be as close as you get to a "free lunch" from a bank. These cards return a certain percentage of purchases to your checking account, ranging from 0.25 percent to a whopping 25 percent when you use U.S. Bank's Flexperks card for purchases from select retailers. (See chart below.)

All of the country’s top debit-card issuers offer a type of rewards debit card, but only three -- Bank of America, Chase and U.S. Bank -- offer cash-back debit cards. Smaller regional banks have cash-back debit-card offers as well, as does PayPal. More offer non-cash-back rewards cards, which offer points, redeemable for miles and other gifts instead of cash.

Debit rewards grow in use
Whether they offer cash or points, debit cards with rewards are a growing trend. In 2008, 17 percent of consumers reported having a rewards debit card, up from 13 percent in 2005 and 8 percent in 2003, according to BAI, a Chicago-based banking industry research firm.

The trick to making the most of the card is ensuring that your debit-card use and spending habits will compensate for any fees and restrictions on the card. Perhaps the biggest trick is in adjusting how you use the card itself.

For example, you don't take the usual debit-card steps of swiping your card and entering the PIN. Most debit rewards card require you to sign. 

Instead of choosing "debit" at the register, you select "credit" and sign the sales receipt. This PIN-less signature procedure makes your debit card act like a credit card. While the difference between signing and using a PIN may be insignificant to most consumers -- as funds are still automatically withdrawn from your checking account -- it makes a big difference for banks. In fact, it's how they fund cash-back debit cards.

Banks and card processors charge retailers fees for the privilege of accepting your card. When you use your debit card as a credit card, banks collect that fee, which ranges from 1 percent to 4 percent of each purchase. Those fees are often used to offset the cost of cash-back and other reward programs. PIN-based transactions, however, cost much less to process. Merchants like that -- and the fees have become controversial as a result -- but the signature-based transactions are the ones that usually earn the most debit rewards.

Cash-back traps
Here are four more ways cash-back debit cards can take a bite of your "free" money:

  • Minimum required balances: First American Bank, based near Chicago, requires customers to maintain a $500 minimum daily balance. If they don't, a $6 monthly fee will apply. Given the bank's small cash-back percentage, that fee could easily eat up any profits a customer might see.
  • Frivolous spending: To earn back a $50 annual fee on a debit card that offers 1 percent cash back, you'd have buy $5,000 worth of stuff in a year. That's fine if the money is spent on useful items such as gas and groceries. Problem is, a cash-back debit card could lure you into buying things you don't need, Fisher says.
  • Overdraft fees: PIN-less transactions, like traditional debit-card transactions, draw funds straight from your checking account. If you get into negative-balance territory, overdraft fees could wipe out any cash-back benefits. One example: Chase's overdraft protection plan charges a $10 fee each time it transfers funds from one of your accounts to another to cover overdrafts. At 3 percent back, it would take $333 worth of qualifying purchases for you to earn back that $10 fee.
  • Restrictions on purchases: Some cards offer cash back only on purchases from grocery stores, gas stations or select online retailers. Others return the cash in the form of a gift card good only at selected stores. Those cash-back cards will only yield cash if you're a regular customer of those retailers.

Still worth it to many
Even with all the fine print, cash-back debit cards have plenty of fans.

Wendi Riggens, a photographer who lives in Burlington, Iowa, dropped her U.S. Bank cash-back debit card when the bank changed the program to include only selected retailers, few of which have stores in her small town.

She misses the card, which earned her and her husband about $150 over two years. "Ten dollars here and there was a nice thing to see when we logged into our checking account," says Riggens, 28.

The good news is that Riggens discovered that her PayPal debit card, which she uses for business and personal expenses, offers cash back. Thanks mostly to $1,600 in vacation expenses, the card has earned her $35 to $40 this year.

"It's not a lot, but it's something," she says.

Worth considering, experts say
If your bank offers a cash-back debit card, it's worth investigating, says David Jones, president of the Association of Independent Credit Counseling Agencies, a nonprofit based in Fairfax, Va. "In most cases, they're a better deal than the (cards) that don't offer cash back. You get to reap cash from the expenditures you make," he says.

 

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