How do cash-back credit cards work?

What is a cash-back credit card?

A cash-back credit card earns you a percentage of money back from your spending with the card. You can earn anywhere from 1% to 5% back from every purchase.

To get your cash, you may have to reach a certain threshold, such as when you have a balance of at least $20 in reward money.

You may take the cash as a check, or have it deducted from your credit card bill, or receive it in the form of a gift card.

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Why do credit card companies give cash back?

Why are credit card companies so eager to give away money? When they give you rewards, card companies aren’t taking a loss so much as they’re sharing a profit.

Credit card issuers charge merchants fees for every transaction. With rewards credit cards, the issuers simply pass some of those earnings on to you.

For example, a card company may take 3% from merchants for each transaction. Rather than keeping all that money, the issuer may offer to give cardholders two-thirds of each fee (2%), to incentivize people to sign up for the card.

More: Find the best cash-back credit card

Types of cash-back credit cards

Cash-back credit cards can be separated into three main categories:

• Flat percentage
• Tiered rewards
• Bonus category

Flat percentage cash-back cards are just as they sound — they pay cash back at the same rate for all purchases.

These cards are best for people who want decent returns without having to overthink it. The trade-off for this convenience is that you typically only earn 1% or 2% for each transaction.

Tiered rewards cards are great for people who tend to spend more on certain things.

If you do all of the grocery shopping for your household and a lot of the driving, a tiered rewards card that pays out a higher percentage for groceries and gasoline may be an excellent option. You’ll get a smaller return on other purchases.

Bonus category cards are for dedicated rewards earners. They offer high rebates of up to 5% in specific spending categories, such as at restaurants or at gas stations.

The bonus categories can change every quarter, and you may have to register, or "opt in," for the bonus category each quarter.

Your spending that earns the bonus may be capped at a certain amount, like $1,500 during the quarter, and purchases in other categories will likely earn you just 1% cash back.

Start earning today: Check out today's best cash back credit cards.

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How do you master cash-back rewards?

You want to choose a credit card that best suits your spending habits, and that won't lure you into spending more than you should, just to chase after rewards.

Never buy what you don’t need. Track your spending for a month, and pick a card that's tailored to what you already spend.

If a card has an annual fee, weigh whether your rewards will more than make up for that cost. And, always make sure you pay off your balance each month.

Credit card interest rates can reach more than 17%. So, carrying over a balance for a couple of months will quickly eat away at your returns. In other words, don't earn cash back — and then give it right back to the credit card company!