Financial incentives and penalties can motivate many consumers to change their spending habits. The lure of a lower interest rate on a balance transfer card; the reluctance to pay a surcharge for using a credit card; and the prospect of earning a cash back reward, can all influence the way consumers make use of their plastic. A study released from the Chicago Federal Reserve makes some clear observations about cash back credit use which concludes consumers end up spending more and acquiring more debt, in pursuit of a reward.
The average cash back reward which is earned through credit card use is $25. Card issuers benefit by more than that amount when they issue rewards cards as such cards tend to increase consumer spending. However the increase which the card issuer gains is often at the expense of another card issuer, making cash back cards a cost effective way of enticing rival card companies customers to change to their product. Even initial statement credits can prove to be cost effective for the card companies as they generally reward a set level of spending within a certain time frame, with the statement credit offered.
Interestingly the Chicago Federal Reserve Study shows that total credit card balances held on record by the credit bureaus change little when a consumer actively uses a rewards card, remaining constant. Average monthly spending increases by approximately $79 when a rewards card is used, but consumers who never carry a balance continue to pay the full balance each month. Those who routinely carry a balance are more likely to carry a higher monthly balance due to increased spending and thus reward the cash back credit card issuer with their interest payments. When the debt is carried forward the average increased debt becomes $191.
Card holders who had been inactive also increased their credit card spending when tempted by cash back rewards. The study concluded though that as balances remained constant consumers were simply substituting spending from another credit card. This demonstrates that the main benefit to the card companies is stealing competitors customers in the likelihood that a card balance will be carried which will accrue interest. Cash back cards can inspire loyalty in consumers who are pleased to receive a reward for using their plastic, and loyal customers extend the database of desirable customers to sell other products to.
Consumers are becoming savvier regarding both financial penalties and rewards. When Ikea introduced a 70 pence surcharge in the UK on credit card transactions, credit card sales fell by 15%. The surcharge was not even a percentage of spending but it still deterred some customers.
Consumers who spend more in the hope of obtaining a cash back reward should always clear the balance in full to reap any benefit. Interest charges simply negate any rewards benefit if a balance is carried.
Source: Chicago Federal Reserve