Discover, which deserves much credit for transforming the card industry, introduced the first cash-back, no-fee card in a catchy commercial during the 1986 Super Bowl. The card offered a cash rebate of up to 1% on every purchase made using it. At a time when many cards had annual fees and when cash rewards were unheard of, Discover’s new card certainly stood out in a big way. No one had ever offered a no-fee card that gave cash back to boot.

Airline reward cards, which typically offer frequent-flyer miles for every purchase you make on the card, began to grow in popularity as well back then. When the popular Citi/AAdvantage card debuted in 1987, this co-branded card (meaning it was affiliated with both American Airlines and Citibank) was among the first to offer miles that could be redeemed for free airline tickets.

One of the primary reasons for their increasing appeal is the stiff competition among card issuers, who have to work hard to make their cards stand out in the deluge of offers we receive every year. Tempting us with rewards is one of their best bets for getting us to apply for and use their cards. That’s why their direct-mail campaigns consistently include more sales pitches for reward cards than nonreward cards. For example, according to Mintel Comperemedia, a Chicago-based market research firm, 55% of all credit card direct-mail promos had a reward component in 2007.

These programs have become so popular in the last few years that it’s hard for card issuers to compete in today’s market without a rebate program. Even better from our perspective as cardholders, their competition means increasingly generous rewards for us. I’ve been amazed over the years at how issuers are constantly trying to one-up each other with ever more enticing cards.

A good illustration of how competition has made reward cards more appealing involves rebate percentages. Until a few years ago, reward cards typically offered a 1% cash rebate or 1 reward point for each dollar spent. Now it’s not uncommon to see reward cards offering rebates up to 3% and even up to 5% on certain purchases.

Imagine getting 3% to 5% back just for using a particular piece of plastic. That’s more than we often earn on our savings at the bank! Moreover, we have to pay taxes on the money we earn in our savings account. Not so with card rebates, which are generally tax-free. (Consult your tax advisor for more info.)

This competition is working to our benefit in another way: Issuers are tempting us with more flexible redemption options. Historically, reward cards allowed cardholders to earn only cash rebates, airline tickets, a narrow selection of merchandise, or gift cards. Lenders are now trying to woo us by presenting many more choices in how we can capitalize on our rewards.

Chase’s Freedom Card, introduced in 2007, is a good example. Marketed aggressively through flashy TV ads featuring the hit song “I’m Free” by The Rolling Stones, it gives cardholders a lot of control over their reward choices. They can choose cash rebates, gift certificates, hotel stays, car rentals, travel on most airlines with no blackout dates, and/or a wide array of merchandise.

In their quest to get us to use their cards, lenders will no doubt introduce other reward cards and modify their existing programs to increase flexibility and customer control. And their popularity will likely grow even more as programs become increasingly specialized and targeted to tempt very specific markets. As Comperemedia puts it:

Finally, the growth of the Internet has also helped spur Americans’ seemingly insatiable appetite for card rewards. Case in point: On a whim back in 1996, Peter Flur, a research engineer from Charlotte, North Carolina, started an online community called the Grapevine, devoted to card rewards. The Grapevine was simply an expression of Flur’s personal interest in the subject, but it has since morphed into a popular online community where people discuss reward cards every day. Similarly, the active CardRatings.com forum has thousands of user tips on making the most of reward cards.

Although our love of reward cards is a great thing, as with any love affair, there are some potential pitfalls. Follow these tips to avoid them and maximize your benefits from reward cards.

Perhaps the greatest trap you can fall into is overspending. Studies show that most consumers spend more on a reward card than a nonreward card. So even if you pay off your balance in full each month, if you routinely spend more on a reward card than you can afford, you’ll quickly find yourself in financial quicksand.

Another reason why you might feel a strong temptation to overspend is that reward cards can become quite addictive. The more you spend, the greater the rebate. Watch out for that, especially if your card company tries to egg you on to spend more with what economists call “purchase acceleration.”

When you near a reward threshold, the lender sends you a letter or an email trying to get you to spend more. “It’s a way for issuers to remind their customers that they’re getting close to cashing in,” explains Lars Holmquist, president of TSYS Loyalty, which helps financial institutions develop loyalty programs.

Issuers also know that consumers tend to spend more after getting a reward. If you get a free airline ticket as a reward, for example, you’re likely to spend more on the trip itself (hotel room, meals, souvenirs, and so on).

To avoid temptation, strictly adhere to your monthly budget. If you don’t have a budget, create one. Homemoneyhelp.com, operated by my endearing friend Terry Rigg (aka Grandpa Terry), is a great resource for free budgeting tools and advice. Similarly, The Budget Kit (Kaplan Publishing, 2008) by Judy Lawrence, is chock full of worksheets that make it easy to plan.

When shopping for and using a reward card, be mindful of your average annual spending levels (that is, the average amount you charge on a card during a year). Some reward cards offer reduced rebates if cardholders don’t reach annual spending thresholds.

When estimating your annual spending level, pull out last year’s card statements and total what you spent, or at least look at your average monthly spending for the past three months and multiply by four. If you’ve never used a credit card, you can get a good picture of your spending level by determining what items in your monthly budget can be charged on a card. If checks have been your main form of payment, take a look at your check register.

Similarly, most cards require that you accumulate a certain number of points before you can redeem them. And a few cards offer more generous rebates if you let your reward points grow and don’t cash in your points at the lowest point redemption level.

A good real-life example of this is the Chase Freedom Card, which I mentioned earlier. It allows you to earn a “$50 check once you’ve earned $50 in rewards.” However, as an added incentive, if you save up $200 in rewards, you can redeem them for $250 cash back. That’s right. You can earn a 25% cash-back bonus just by choosing a higher point redemption level—and of course, continuing to charge on that card!

Knowing how many points are required for the rewards you’re most interested in—and how much you have to spend to reach a desired point level—is crucial if you want to get the max from your reward card.

Watch closely for offers like this that come in the mail because this was a mail solicitation only. It’s also proof of how badly issuers want to keep our business. In this case, we hadn’t used the card in a long time. Needless to say, I was delighted to do business with Chase again!

...you don’t carry a balance from month to month. Credit cards that offer cash rebates tend to have a higher interest rate, which usually wipes out any reward you might receive if you carry a balance. If you don’t pay off your bill every month, use a credit card with the lowest interest rate you can get.

Dr. Mary Ann Campbell (CFP), president of Money Magic, Inc., and a money educator, sums it up best: “Cash-back is a good option if you are truly managing your credit cards so you are literally earning that cash, and not turning around and paying it back in any other form.”

Use your rebate card wisely and pay off the balance in full every month. Then the cash you receive is a reward, pure and simple, for all the hard work you’ve done in managing your card responsibly.

...not all cards are created equal, either. As with any other type of card, you should definitely shop around. Ideally, pull out your calculator to determine the best reward card, given your spending habits and lifestyle. Consider it a wise investment of your time, with the payoff being more money. You’ll also get peace of mind from knowing that you’ve done some profitable decision making. (The “Consumer Reviews” section of CardRatings.com is a good place to start because the site enables you to conveniently search for cards by reward types.)

Here are some things to keep in mind when reviewing offers:

Paying an annual fee is a pet peeve of mine, particularly when it comes to cash-back cards. But because only a few cards out of the hundreds and hundreds available charge an annual fee, you shouldn’t have to settle for one that does. If a card with an annual fee seems too good to resist, it’s time to crunch the numbers and compare the benefits to those offered by other cards that don’t have an annual fee.

When comparing benefits, be realistic about which ones you’ll actually use. If a card with a $200 annual fee offers a generous perk, such as a free international companion airline ticket every year, but you’d never use it, then that perk isn’t worth a dime to you! Rarely does the math add up. The one notable exception, which we discus in Chapter 8, “Use Targeted Cards to Your Financial Advantage,” is a relatively new breed of cards that targets affluent card members.

A few cards offer you a greater rebate percentage or some other freebie if you carry a balance. A typical example here is a card that offers a 1% rebate on all purchases but increases that rebate to 2% in any month when you carry a balance.

This scenario should be a big red flag. Any interest that you pay to get a more generous rebate will invariably cost you much more than the amount of cash you get back. Paying 15% in interest on your balance for the privilege of earning an extra 1% rebate is a good way to end up in a pauper’s prison.

If you’re considering such an offer, start with your annual spending level (how much you’ll charge during the year). Figure out how much you’ll pay in interest and fees, and note how much cash you’ll get back. I’d be shocked if you actually ended up receiving more cash than you’d pay in interest and fees. (Please let me know if you do!) Be sure to compare your findings to other offers to determine which one gives you the most back.

Some cash-back cards offer a higher rebate when you shop at such places as supermarkets, gas stations, and drug stores. The precise definition of these “everyday purchases” (as the issuers often call them) should be defined in a card’s fine print, its “terms and conditions.” Read them! The extra money you can earn will be worth a few minutes of your time.

For example, the Citi Dividend Platinum Select MasterCard offers up to a 5% rebate at supermarkets, drugstores, and gas stations:

In other words, supermarkets aren’t departments of superstores (such as Wal-Mart) or warehouse clubs (such as Costco).

Typically, it’s up to the merchant to make sure a purchase is coded correctly to qualify for an enhanced rebate. But you need to read the fine print to know exactly which merchants qualify and who is responsible for making sure transactions are coded properly.

Here’s a great way to find out if the store where you shop currently qualifies for an enhanced rebate and to get the real 411 from people who are maximizing their rebates: Browse through the messages on the CardRatings.com forum or post a question.

Sometimes lenders send out a list of specific merchants where you can earn a higher rebate and/or where there won’t be a “cap” (a limit) on the amount you can earn. If you shop often with the merchants on this list, your earnings will quickly mount up. For the most part, they’re usually online retailers, so if you often shop online, definitely consider this option.

Bullet875, an active member of the CardRatings.com forum, takes advantage of this benefit with his Discover card: “When I purchase things online using the Shopdiscover feature, I can rack up at least another 5–20% in rewards, depending upon where I shop.”

As a general rule of thumb, if you charge less than $10,000 a year, the best deal in cash-back cards is usually one that pays you a flat rebate percentage with every purchase. A flat 1% rebate on all purchases is the industry standard.

Other cards are “tiered”—the more you spend, the higher your rebate percentage. For the greatest returns, be sure you read the fine print and understand how much you have to charge to earn more generous rebates. Tiered cards normally favor cardholders who charge a lot on their card.

One of the primary ways to identify a tiered card is to look for the “up to” clause. For example, with the Blue Cash card from American Express that my wife and I often use, you can earn “up to” 5% cash-back on your purchases. But if you read the fine print, you’ll find that you earn that 5% rebate only after you charge more than $6,500 annually on “everyday purchases.” You’ll receive a 1% rebate on “everyday purchases” below $6,500, while all other purchases start at 0.5% and go “up to” 1.5%, after you spend more than $6,500. So if you spent less than $6,500 on this card in a year, you would be much better off going with another card that offered you a 1% flat rebate on all purchases (and that didn’t require you to meet any spending levels).

You might come across a card that offers an amazing rebate, but when you read the fine print, it applies only to purchases made within a set time frame: the first 30, 60, or 90 days, for example. Pay close attention to what happens to the terms when the set time expires.

Does the rebate drastically decrease, as is typical? Does an annual fee kick in? Will the interest rate increase? (Although you always want to pay your balance in full each month, financial problems do occur. If you end up carrying a balance at some point, you’re much better off with the lowest rate possible.)

There’s usually an annual limit on your rewards, known as a “cap,” but it depends on the card. Some cards enable you to earn cash at a high rate, but they have a relatively low annual cap, meaning that you might not end up with very much. Other cards offer a lower percent back or have rate tiers (the more you spend, the more you earn), but there is no limit to how much you earn. To see which card will benefit you most, figure out how much you plan to charge and how quickly you can get to the higher tiers.

Ira Stoller, who was a sharp, savvy consumer and frequent contributor to the CardRatings.com forum until recently, when he lost his battle with cancer, liked to have more than one cash-back card so if he reached the rebate cap on one, he could start earning cash with another.

Occasionally, lenders mail a check, but more often than not, a credit appears on your statement. With some cash-back cards, you have to request a check or credit while others send you the reward automatically. In some cases, you have to earn a set amount (usually around $25 to $50) before you can receive a check.

Know the details before getting any card. If you’re saving up for a trip, for example, you might rather get an actual check in the mail that you can deposit in your savings account rather than a credit on your statement.

A year is a year is a year, right? Not necessarily. It could be a calendar year or an anniversary year that starts when you’re approved for the card. Knowing how the lender defines the year can mean money in your pocket. If you don’t reach the required yearly thresholds, you’ll be out of luck. At the beginning of the next year, you might be back to zero. Timing, as they say, is everything. (Please remember that I’m not encouraging overspending—just strategic spending!)

Credit card issuers generally reserve the right to change the terms at any time for any reason. This can include the rebate rate itself, the list of merchants where you can earn a higher rebate, and any other detail of the card. It’s vital to read all those fine-print notices you get in the mail (the ones we normally throw in our garbage bin). Bottom line is you should keep your eyes out so that what the lender gives you with one hand isn’t taken back with the other.

Would you like to save money on your mortgage? Who wouldn’t? Citibank says you can save $15,640.37 and shave off 10 months from a $250,000, 30-year mortgage at 6.25%—if you use the Citi Home Rebate card. Rebates are automatically applied to the outstanding balance on your mortgage.

Imagine that—increasing your net worth by $15,000 just by using a particular credit card! Bear in mind, though, that a return like this takes many years and the continued use of the reward card to achieve. This particular example assumes monthly charges of $1,500 on the card for the entire life of the mortgage.

This category includes a few other cards. For example, Wells Fargo introduced a similar card in 2007. This sort of reward—offered in conjunction with other banking products—seems to be a growing trend.

On the surface, using a credit card to pay down debt seems so counterintuitive. But if there’s a hitch, I haven’t found it. You can truly use these unconventional reward cards to your great advantage ($15,000, great!) if you use them wisely. Also, there’s a lot of value in the automated, forced savings principle associated with these cards, especially for homeowners who have a hard time saving.

The main drawback that I see is that these cards typically offer only a 1% rebate on all purchases. Frankly, you can earn a higher return with a lot of regular cash-back cards. Then, if you want to pay down your mortgage, you can simply apply your cash rebate to your mortgage yourself.

We all know it’s important to save for emergencies and retirement. But when it comes right down to it, at the end of the month, not much might be left over. A relatively new breed of reward cards offers a convenient way to help jumpstart or supplement your savings.

These cards have great appeal because your rebate can automatically be deposited in brokerage accounts or high-yield savings accounts—or even in tax-deferred retirement accounts like traditional IRAs and Roth IRAs.

I particularly like the concept of putting rebates in tax-advantaged accounts and having that free money grow for the future. Keep in mind that if you choose to contribute to a tax-deferred account, the rebate normally counts against annual contribution limits set by the IRS. At the same time, if the account is a tax-deductible IRA, you might be able to deduct the rebate as a contribution to the account. (Consult your tax advisor for more info.)

Are college expenses in your future? Reward cards that apply your rebate to a 529 college savings plan might be a good option. Significant tax advantages accompany making deposits into these accounts. Although you probably won’t earn near enough for full tuition, every little bit helps! The rebate and contribution limits vary from program to program, but all rebates you earn go toward the maximum allowed contributions to the 529 savings plan associated with the card. For detailed information on this topic, see Chapter 7, “Start Out on the Right Foot—Credit Cards for Students and Saving for College.”

Tim Winship, publisher of FrequentFlier.com, divides the world into two categories: frequent flyers and frequent buyers. He says the quickest way to earn miles is to fly and use an airline FFP. If you travel often, you might want to supplement an FFP with a credit card affiliated or branded with that airline. Such branded cards let you to combine points earned on the card with the FFP points you’ve earned from flying. (Note there are a few exceptions to this rule. For example, cards issued by Diners Club International and some American Express [AmEx] reward cards that aren’t affiliated with a particular airline allow you to combine points with existing FFP points.)

On the other hand, if you’re a bigger spender than flyer, think about using a generic bank card that isn’t linked to a particular airline. These cards generally offer annual fees of around $20, compared to the fees on branded cards, which are usually between $60 and $80. The other big benefit is that you can choose to redeem your miles with any major airline. As you might expect, branded cards allow you to redeem your miles with only that one airline.

Gary Foreman, a former Certified Financial Planner (CFP) and the founder of the frugal Stretcher.com website, recommends that not-so-frequent flyers keep in mind the times of year they’re most likely to fly. Will it be over the holidays, when there’s a higher chance of blackout dates and seating restrictions? Do you travel as a family? If you’re trying to earn free tickets for everyone, it will probably take much longer and require much more spending.

Fees tend to be considerably higher for airline reward cards than for other types of reward cards. If you don’t charge fairly aggressively on your card, the high fees might cancel out any reward benefit.

When talking to folks, I like to use following scenario to explain this important concept: Let’s say you spend $8,000 a year on your card, earning 1 mile for every dollar spent (which is typical) and paying an $80 annual fee. It’ll take you a little more than three years to earn a free domestic roundtrip ticket on most airlines, assuming the usual 25,000 miles for a free ticket.

But given the $80 annual fee, that ticket won’t be free. At $80 a year for more than three years, it will really cost you $240 in cold, hard cash. We’re talking money right out of your pocket, not rewards. You can fly on a discount carrier to a lot of destinations for $240!

Now let’s see what happens if, instead, you use a typical cash-back reward card with no annual fee. Assuming you charge the same $8,000 a year and earn 1% cash back, you’d get $250 back in a little over three years. At that point, you could just pay for the ticket yourself—without having spent an extra penny on fees.

Of course, a fee might be justifiable, given your lifestyle, especially if you charge more each year and combine your miles with a FFP, making it easier to earn a free ticket in a shorter amount of time. As with any reward card, consider charging routine expenses such as groceries, gas, and utilities to increase your rewards each year.

Unfortunately, many programs do have expiration dates for earned miles. Some require accounts to show activity during a certain time frame to avoid expiration dates. Other cards, particularly bank cards, have firm expiration dates (usually within three years) that can’t be extended for any reason. Read the fine print and make sure you understand the exact requirements of a program.

FrequentFlier.com’s Tim Winship says that, in today’s market, it is important to use earned miles as soon as the threshold for a free ticket is reached because if an airline fails, it’s unlikely that another airline will step in and allow you to still use your accrued miles. With so many airlines competing and experiencing financial difficulties, absorbing all those miles is too high a cost.

On top of the danger of losing miles to failed airlines, which is a cyclical situation, Winship points out that there’s a long-term loss in the value of frequent-flyer miles. That might be due to declining ticket prices, higher award levels, and/or fewer available award seats. For example, a program could up the ante, making the price of a free ticket 35,000 miles instead of 25,000. That erosion in value, which is expected to continue, creates a compelling reason to use miles sooner rather than later. So instead of saving all those miles for retirement, go ahead and take that dream vacation now!

Despite all the negative factors associated with airline cards (you can probably tell that I’m not a big fan), there’s a unique advantage to signing up for one—if it gives very generous bonus miles just for getting the card, like many of them do. Branded cards tend to be the most generous with several offering anywhere from 15,000 to 25,000 bonus miles.

So if you play your cards right (pun intended), you can earn enough for a free airline ticket in a very short amount of time. Consider the experience of a coworker of mine, Heshan Demel, who got 25,000 miles for signing up for his American Express Delta Card and received 15,000 miles soon after his first purchase.

He recently flew with his wife from Arkansas to New York City for free, thanks to this card. “It was a pretty easy process for me, with no complications,” Heshan reports. All he had to do was go to Delta’s website and make the reservation. He had a little more than 50,000 miles in his SkyMiles account (he already had some miles in his account before he got the card) and cashed in 25,000 miles for each ticket. The only possible catch was that he would have to spend double the amount of miles if he flew during the weekend. This didn’t matter to him because he flew to New York on a Monday and came back a week later. A small processing fee of around $10 per ticket was charged, but apart from this, Heshan and his wife got two free airplane rides to New York and back.

Needless to say, Heshan’s wife was quite impressed with his savvy card usage.

Here are a few other tips that will help you make the most of your reward cards:

Finding the right card takes a little research and use of your math skills, but the payoff in the end is worth it, whether or not you choose to apply for an airline reward card. CardRatings.com makes it easy to evaluate and compare the different airline reward cards available. Good luck and bon voyage!

Table 2.1 shows a handy way to compare cash-back, airline, and gas reward cards, highlighting the pros and cons of each type of card: