How does a Rewards Credit Card work?

Co-author: TJ Ryan

If you’ve heard of credit cards, chances are you’ve heard of credit card rewards. Here’s a quick explanation of how they work.

Rewards credit cards are popular: approximately 33% of the thousands of visitor searches for credit cards on CANSTAR’s credit card comparison tables are for a frequent flyer card, and another 22% are for a general rewards card.

There are more credit cards being used in Australia than ever before, with more than 16.5 million credit cards in circulation as at July 2016.

 

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How do Rewards Credit Cards work?

A credit card is a form of unsecured personal loan that gives the cardholder access to a revolving line of credit. That revolving line of credit is accessed most usually via a small plastic card – hence, the credit card.

Rewards credit cards give you extra benefits that you earn according to how much money you spend on your credit card. The bank converts your spending into rewards points, and when you redeem those points, the bank converts them into rewards for you.

There are four main types of rewards, and they are:

Depending on the rewards program you choose, every dollar of spending on your card can accrue those points that can be converted into rewards. Some lenders allow you to set up auto-redemption, so that every time you reach a certain number of points, they are automatically redeemed in the method of your choice.

It can be a nightmare for the typical spender to try and work out whether their rewards program is good value or not. Given all the points that you earn, what are you actually getting in return? So here’s a simple way to cut through the confusion of rewards. We call it the NET REWARD RETURN and it calculates:

  • the dollar value of points earned each year,  less
  • the cost of the card and reward program each year

To tell you whether or not you’re actually ahead.

It works like this:

credit card rewards return formula

So as an example:

credit card rewards return example calculation

In the above example, given that it costs 150 points to get $1 of reward, earning 24,000 points will equate to a yearly reward of $160.

Just remember that some programs limit the amount of points you can earn with points capping per year or per month, and other programs let the points expire if you don’t redeem them within a certain timeframe.

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All in all, credit card rewards can seem like a good option when it comes to purchasing a credit card. However, it is important to take into account outliers such as high interest variable rates, and reward limitations when making your decision. In 2016 CANSTAR rated 169 rewards credit cards across 60 providers.

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