Credit card rewards can be appealing, earning cash back and travel points that feel like an easy win for cardholders who pay in full. A new Harvard working paper questions who foots the bill for those rewards, and estimates that interchange fees transfer about $30 billion annually from cash and debit card users to credit card users. Rewards cards aren’t always a bad deal, but shoppers should look closely at what they earn — and what they pay — at the register.
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What Harvard Research Says About the Cost of Credit Card Rewards
When customers use cards, whether debit or credit, merchants pay processing fees, but higher-rewards credit cards typically cost more to accept. Premium cards have average interchange fees of about 2.1%, compared with 1.7% for basic credit cards and 0.7% for regulated debit cards.
A Harvard working paper, “Who Pays for Payments?,” estimates that cash and debit users subsidize rewards when merchants charge the same price to all customers while building payment costs into overall prices.
The research estimates $30 billion in annual transfers from cash and debit card users to credit card users. That includes about $9.2 billion transferred from households earning less than $150,000 to higher-income households.
These aren’t separate fees that appear on receipts but are typically reflected in higher costs as merchants raise prices to cover card processing fees.
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Cash and Debit Users Pay the Same Price Without Rewards
Some merchants don’t set separate prices based on payment method and instead absorb card fees or raise prices. They may add a credit card surcharge or offer a cash discount.
“Merchants generally look at these fees as a cost of doing business,” says Adam Neiberg, global banking senior marketing manager at data and AI provider SAS. “If they don’t differentiate prices or have a credit card surcharge, they can adjust prices based on their merchant processing costs.”
When the price is the same for all customers, shoppers who pay with cash or debit cards may help cover the cost of card acceptance for rewards cards without receiving rewards in return.
The effect isn’t the same at every store. Grocery stores, gas stations and large retailers often pay lower credit card fees with negotiated rates or sector discounts. The Harvard research found that people who prefer cash, debit or premium cards often shop at different merchants, which reduces the overlap where cross-subsidization happens.
“Accepting payments, no matter how you do it, carries a cost,” says Matthew Goldman, founder of Totavi, a boutique fintech consulting firm. Even cash can have a cost. For example, Goldman adds that costs associated with counterfeit cash, travel to banks or cash management can cost as much or more than cards.
Lower-income consumers are more likely to use cash and debit, and higher-income consumers are more likely to use credit cards with premium rewards, so the shoppers who receive high-value rewards are more likely to have higher incomes.
The research estimated that households earning less than $150,000 lost about $88 annually on average, while households earning more than $150,000 gained about $390 annually on average.
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How Should You Pay?
The study doesn’t argue against rewards cards but takes a closer look at who benefits and absorbs costs.
People who pay with cash or debit may pay the same price as premium card users, but they don’t receive cash back or points for their purchase. The best choice depends on whether a card’s rewards outweigh its costs, including annual fee, interest, surcharges and whether you’ll pay in full.
“If you plan on paying off your balance each month — what the credit card industry calls a transactor — you should investigate credit card rewards programs,” says Neiberg. “If you plan to revolve on a credit card — i.e., carry a balance from month to month rather than paying it in full — then credit card rewards programs might not be worth it. Interest on your remaining balance can quickly eat away at any reward perks and benefits you receive.”
For example, paying a 3% credit card surcharge to earn 2% cash back costs you 1% in fees before considering annual fees or interest.
Rewards cards can make sense when you use them for spending that’s already in your budget, paying the balance in full each month, and if it’s offering enough rewards and benefits to offset any annual fee.
Cash or debit may be a better choice when merchants offer a significant cash discount or a credit card surcharge is larger than the rewards you’d earn. Cash or debit can also be a good choice if you’d otherwise carry a balance and pay interest.
“At first, it may seem that cash back and points are a benefit that no one should turn down,” says Angelo DeCandia, professor of business and accounting at Touro University. “But a bit of reflection will quickly demonstrate that it never makes sense to pay $2 to receive $1.”
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Are Credit Card Rewards Making Everything More Expensive? originally appeared on usnews.com
