Who pays for your rewards? Indebted credit cardholders

CREDIT CARDS with rewards are rewarding only for those who know how to profit from the system, according to a paper released by the Federal Reserve.

Consumers with higher credit scores benefit the most because they tend to spend more money — thus earning more rewards such as cash back or miles — and pay on time, according to the study. Card holders with lower credit scores overspend to try to earn more points and incur higher interest payments stemming from outstanding balances.

In all, the economists estimate that about $15.1 billion is transferred annually from less to more educated, poorer to richer, and from areas with a higher percentage of minorities to whiter ones. The results aren’t so much driven by income as by the level of financial sophistication, they said.

“Credit-card rewards are often framed as a ‘reverse Robin Hood’ mechanism in which the poor subsidize the rich,” wrote the researchers. “Our results, however, show that this explanation is at best incomplete.”

Reward cards are highly popular in the US — accounting for 60% of all new cards in 2019, according to the paper. And financial firms typically offer lower interest rates than on cards without rewards to lure customers.

Banks profit from reward cards across all credit scores, the researchers found, but they benefit the most from near-prime and prime card holders — those with fair or good-quality financial situations, according to the paper. With low credit-score customers, banks mostly generate revenue from interest payments.

Reward cards induce sub- and near-prime consumers to “overspend and subsequently over-borrow” on their credit cards compared with those who use cards without rewards, the researchers said.

The study was conducted by economists at the National University of Singapore, the International Monetary Fund, the Center for Economic and Policy Research, and the Federal Reserve Board. — Bloomberg