Cash back credit cards are some of the most popular rewards credit cards available today. These rewards credit cards are relatively easy to understand. Redeeming the cash back you earn with them is fairly simple, too.
How you use the cash back you accumulate can make a big difference. Rather than using your credit card rewards to buy luxury items or pay for travel expenses, you can improve your overall financial health. While using cash back to put yourself in a better financial position may not be as fun as the alternative, you may be glad you made the smarter money move down the road.
How Earning and Redeeming Cash Back Works
Each cash back credit card has its own rewards program that determines how you earn and redeem your cash back rewards. That said, most programs have much in common. You typically earn rewards by using your credit card to make purchases. The cash back rate you earn depends on the card.
Some cards offer cash back as a flat percentage of everything you buy. Others offer bonus cash back in particular categories such as gas stations, grocery stores or restaurants. “If you’re clever with those cards on every purchase, you could earn somewhere between 1 to 4 or 5 percent cash back,” says Justin Bailey, co-founder and chief technical officer of the financial planning app Vimvest.
Cash back may apply automatically as a statement credit or be put into a rewards account where you have to take action to redeem it. When you’re ready to use your rewards, you can call the credit card issuer or log in to your online account to request your cash back.
How you can redeem your cash back rewards will also vary depending on the card. Most cards allow you to request at least one or two of the following options: a check, a statement credit or a direct deposit into a bank account. Some credit card rewards programs even allow you to automatically transfer your cash back to a savings account. Automatic savings account transfers can help you avoid being tempted to use the money for other things, says Logan Allec, CPA and owner of the personal finance blog Money Done Right.
Wise Ways to Redeem Credit Card Cash Back
The smartest use for the cash back you earn depends on your particular financial situation. What may be a smart move for one person may be less than optimal for someone else. Here are five solid ways you can use your cash back to improve your finances.
Pay off high-interest-rate debt. Getting out of debt as soon as possible is extremely important when it comes to taking advantage of extra income such as cash back, says Bailey. If you have high-interest-rate credit card or personal loan debt, using your cash back to make extra principal payments on that debt is a good choice most of the time. Paying more on your debt lowers the total amount of interest you pay and saves you money in the long term.
It also helps you pay the debt off faster. “Debt is like a monster. The higher the interest rate, the faster that monster grows, so you want to knock that out as quickly as humanly possible,” says Allec.
Pay for major planned (or surprise) expenses. The cash back you earn can help you afford life’s annoying large purchases that no one wants to pay for. If you own a car or own a home, large expenses such as new tires or a water heater might pop up. And when the time comes to make the purchase, if you don’t have the money, you must turn to debt.
You know that these major expenses will eventually happen, so you can lessen their impact on your budget by setting aside your cash back to pay for them. While you probably won’t earn enough cash back in a couple of months to pay for a set of tires or a water heater, saving cash back over a longer period might work.
“Every little bit counts, and I think that’s the beauty of cash back, especially over time,” says Allec. If you don’t have enough time until you need to buy the item, you can use both cash back and regular savings to work toward your goal.
Start or grow an emergency fund. An emergency fund is an essential tool you can use to improve and protect your finances. Most experts recommend saving from three to eight months’ worth of living expenses for a proper emergency fund. Your emergency savings can help you make smarter long-term decisions without worrying about the immediate financial impact. Emergency savings can also help you avoid falling into debt by providing a buffer for major unexpected expenses or a temporary reduction in income.
Just like the cash back you earn in a few months probably won’t pay for a water heater, your cash back likely won’t be able to cover a few months of living expenses, either. That said, every dollar of cash back you set aside to build your emergency fund helps you reach your goal faster and protect the rest of your finances a little bit more, too.
Save toward major goals. Cash back from credit cards can still help improve your finances even if you don’t have high-interest-rate debt and you’ve already built an emergency fund. Major financial goals, such as saving for a down payment on a car or a house, take a long time to reach.
Allocating the cash back you earn from your credit cards can help you reach these goals faster. It may not seem worth it to put the relatively small cash back you earn toward these goals that require thousands or tens of thousands of dollars, but it can make a measurable difference.
Normally, people have to save for these goals for years. In some cases, adding the cash back you earn on top of your regular savings can help you achieve your goals just a bit sooner.
Invest for your retirement. Generally, the biggest impact your cash back credit cards can have is investing for your future retirement needs. “When you’re getting cash back and you’re investing that cash back over the next few decades, that cash back you receive today is going to multiply,” says Allec.
This is due to the power of compound returns, which means the money you earn by investing your cash back adds to your investment balance. Then, those earnings can earn additional earnings on themselves. “If you’re relatively young, say 30 or so years old, leveraging these cards can seriously benefit you,” says Bailey.
The amount of cash back you earn each year might only amount to a few hundred dollars, even if you put every possible purchase on a credit card. That said, applying it in a constructive rather than frivolous way can make a real difference over the long term. Using your cash back this way can make a seemingly insignificant amount of money turn into a major benefit later in your life, says Bailey.
Let’s say you earn $500 cash back each year. If you invest your $500 cash back from this year and earn a 6 percent annual return for the next 30 years, that $500 will turn into $2,871. If you’re even more diligent and invest your $500 cash back this year and every year for a total of 30 years while earning that same 6 percent annual return, you’ll end up with $44,775.
Maximize Cash Back by Redeeming for the Best Value
Some credit cards allow you to redeem your rewards for multiple options rather than only cash back. Travel rewards cards, such as the Chase Sapphire Preferred Card, may allow you to redeem points at a higher value if you use certain redemption options. This particular card allows you to book travel through the Chase Ultimate Rewards travel portal for a value of 1.25 cents per point.
To get the most out of your credit card rewards and put yourself in the best financial position possible, try to maximize the value of your rewards within reason. For instance, if you had travel coming up and you were planning to pay cash for the trip, it often makes more sense to redeem your rewards at the higher 1.25 cents per point value by booking through the Chase Ultimate Rewards travel portal. Then, take the cash you would have spent on that travel purchase and put it toward the goal where you’re allocating your cash back rewards.
Remember that cash back is only valuable if you’re not carrying a balance on your credit cards. Otherwise, any interest you pay likely exceeds the cash back you earn. As long as you aren’t carrying a balance on your cards, using that cash back productively can help set you up for a brighter financial future.