How does cash back work?

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When you enter into the world of cash back credit cards, it can be pretty exciting seeing all of the opportunities you have to earn.

But you may find yourself asking questions like “How does cash back work?” or “What does cash back mean?” or “What’s the best cash back credit card for me?”

These are great questions to ask. By getting the right answers, you can maximize your benefits.

What does cash back mean?

Simply put, cash back is when you get cash back on a purchase that you make. The most popular forms of cash back are credit cards that offer a reward in return for using the card to make a purchase. For example, if you have a credit card that offers 5 percent cash back on all purchases and you make a $10 purchase, you will get 5 percent of that purchase (50 cents) back in some way, shape or form.

You may find online stores that offer cash back promotions as well. The cash back rewards may be sent to you via check or transfer, or they could be applied to your current or next purchase.

The bottom line is that cash back is a term that refers to a consumer getting part of the purchase price of an item or service returned to them as a reward.

How to earn cash back

Earning cash back rewards through credit cards is simple. All you have to do is sign up for a card that offers this type of reward and use the card to make your purchases. While the overarching premise is always the same, cash back credit cards do have different methods of calculating just how much cash back you’ll be receiving.

Flat rate

The simplest form of cash back credit card is a flat-rate card. With this type of bonus program, consumers get a flat percentage reward on all purchases. Generally, it doesn’t matter what you are buying, as long as you are using the credit card to make the purchase. For example, the Chase Freedom Unlimited card offers 1.5 percent cash back on all purchases. For every $1 you spend, you get $0.015 back in rewards.

Bonus categories

Bonus category cards may work in conjunction with a flat-rate plan. With these cards, consumers earn a higher percentage cash back reward on certain purchase categories. The bonus category is most commonly something like travel, entertainment or food-related.

For example, the Capital One SavorOne Cash Rewards Credit Card offers 1 percent on all purchases. However, you can earn 2 percent on grocery store purchases and 3 percent on dining and entertainment.

Rotating categories

Rotating category cash back cards are similar to bonus category cards, except the categories you earn extra cash back on change from time to time.

For example, the Discover it® Cash Back card operates on a 5 percent cash back calendar. Every quarter of the year, a new set of categories earns you 5 percent on purchases, on up to $1,500 in combined spending, after you activate. In January, February and March of this year, for example, cardholders could earn cash back at grocery stores, Walgreens and CVS.

But in April, May and June, that changed to gas stations, wholesale clubs, Uber, Lyft and Home Depot.

How to use cash back rewards

  • Statement credit: One of the most straightforward ways to use your cash back rewards is to have them applied to your credit card statement. If you have $10 in cash back and owe $100 on your card, you now only owe $90.
  • Pay for purchases: Some credit card companies, like Capital One, allow you to apply cash back rewards to a specific charge. While this has the same effect as a statement credit, the mental victory of getting a reduced price or a specific purchase for free is worth every penny of the option.
  • Gift cards: Cash back rewards can often be converted into gift cards that you can use to purchase items online or in person.
  • Deposit into an account: You can also use your cash back rewards to add to your savings account or have it put into your checking to cover bills and other expenses. Generally, you will need to have the savings account or checking account at the same bank you have the cash back rewards credit card with.
  • Check: If you want to tangibly feel the effects of your cash back reward, you can have some companies send you a check. This is also a great option if you want to put the money into a savings or checking account that’s held with a different bank.

Making the most of your cash back cards

Use the right card for every purchase

One of the best strategies for maximizing rewards is having multiple cash back cards with different percentages for various purchase types.

For example, you could use the Capital One SavorOne card every time you eat out or spend money on entertainment (4 percent cash back) and then use the Discover it® chrome when you fill up your car (2 percent back on gas and restaurants purchases, on up to $1,000 in combined spending per quarter, plus, earn unlimited 1% cash back on all other purchases).

Don’t carry a balance

The money you earn through cash back rewards can get canceled out if you carry a balance and incur interest costs on your card. While it still will offset costs, the best way to get maximum value is to pay off your balance monthly.

Continually shop for new offers

While you should avoid jumping credit cards too frequently, always keep an eye out for any new deals that are significantly better than what you’re currently receiving.

Know the program’s ins and outs

Answering the question, “How does cash back work?” is important on a broad scale, but it’s even more important to answer the question for the specific cards you have. Know the ins and outs so you can maximize your returns.

Don’t get caught up bonus chasing

Remember, cash back is always a percentage of money that you’re spending (minus some initial bonus offers). Make sure you don’t get caught overspending just to earn more rewards. No matter how great the offer is, that’s still going to be more money going out than is coming back in.

Best cash back credit cards for 2020

Chase Freedom Unlimited

The Chase Freedom Unlimited is one of the best no-annual-fee credit card options on the market. At sign-up, you’ll get a $200 bonus for spending $500 in the first three months and zero percent APR on purchases and balance transfers for 15 months. On top of that, you can earn an unlimited 1.5 percent cash back on every single purchase. If you don’t want to fuss with using different cards to maximize rewards, the Chase Freedom Unlimited is a great option.

Capital One SavorOne Cash Rewards Credit Card

The Capital One SavorOne Cash Rewards Credit Card is a great option for consumers who spend money on dining, entertainment and groceries. The card comes with an unlimited 3 percent cash back on dining and entertainment, 2 percent at grocery stores and 1 percent on all other purchases, and it has no annual fee.

If you’re looking to earn more, you can upgrade to the Capital One Savor Cash Rewards Credit Card*, which delivers an increase to 4 percent on dining and entertainment and offers 8 percent back on tickets purchased through Vivid Seats.

Discover it chrome

If you drive a lot and like to eat out, the Discover it chrome credit card could be a good fit. The card comes with 2 percent cash back from gas stations and restaurants, up to $1,000 in combined spending per quarter. All other purchases earn 1 percent cash back. Additionally, as an added perk, Discover will match 100 percent of your cash back earned during the first year.

Bottom line

Cash back is a fantastic way to earn money on purchases you’re already going to make. Credit card companies offer the perk to try and win your business. The best part is that you can take advantage of the rewards even if you never carry a balance or pay interest on your card.

Be sure to analyze your spending habits to determine which cash back rewards credit card is best for you.

*The information about the Capital One Savor Cash Rewards Credit Card has been collected independently by Bankrate.com. The card details have not been reviewed or approved by the card issuers.