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Cash back credit cards are among 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 also pretty straightforward.
How you use the cash back you earn 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 rewards to get you in a better financial position isn’t as fun as the alternative, you can be happy that you got the smarter money down the road.
How Cash Back and Cash Back Work
Each cash back credit card has its own rewards program that determines how you earn and redeem your rewards for cash. That said, most programs have a lot in common. You usually earn rewards for using your credit card to make purchases. The cash back rate you earn depends on the card.
Some cards offer cash back as a fixed percentage of everything you buy. Others offer bonus cash back rewards in particular categories such as gas stations, grocery stores, or restaurants. “If you are skilled with these cards with every purchase, you could earn between 1 and 4 or 5% cash back,” says Justin Bailey, co-founder and CTO of the financial planning app Vimvest.
Cash back can be automatically applied as a statement credit or placed in a rewards account where you must take action to redeem it. When you’re ready to use your rewards, you can call the credit card issuer or log into your online account to claim 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, credit statement, or direct deposit to a bank account. Some credit card rewards programs even allow you to automatically transfer your money 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.
Smart Ways to Use Cash Back Credit Card
The best use of the cash back you earn depends on your particular financial situation. What may be a smart decision for one person may be less than optimal for someone else. Here are five solid ways to use your cash back to improve your finances.
Pay off high interest debt. Getting out of debt as early as possible is extremely important when it comes to taking advantage of additional income such as cash back rewards, Bailey explains. If you have a high interest rate credit card or personal loan debt, using your cash back to make additional principal payments on that debt is a good choice most of the time. Paying more on your debt reduces the total amount of interest you pay and saves you money in the long run.
It also helps you pay off debt faster. “Debt is like a monster. The higher the interest rate, the faster that monster grows, so you want to get rid of it as quickly as possible,” Allec explains.
Pay for major planned expenses (or surprises). The cash back you earn can help pay for life’s boring big purchases that no one wants to pay for. If you own a car or a house, major expenses such as new tires or a water heater can occur. And when the time comes to make the purchase, if you don’t have the money, you have to go into debt.
You know these big expenses will happen eventually, so you can reduce their impact on your budget by setting aside your cash back to pay for them. While you probably won’t make enough money in a few months to pay for a set of tires or a water heater, saving money over a longer period of time might work.
“Every little bit counts, and I think that’s the beauty of the Cash Back Rewards, especially over time,” says Allec. If you don’t have enough time until you need to purchase the item, you can use both Cash Back Rewards and Regular Savings to reach your goal.
Start or expand an emergency fund. An emergency fund is an essential tool you can use to improve and protect your finances. Most experts recommend saving three to eight months of living expenses for a suitable 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 going into debt by providing a buffer for large unforeseen 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 probably won’t be able to cover a few months of living expenses either. That said, every cash back dollar you put aside to build your emergency fund helps you reach your goal faster and protect the rest of your finances a bit more.
Save towards major goals. Cash Back Credit Cards can still help improve your finances, even if you don’t have high interest debt and have already built up an emergency fund. Major financial goals, like saving for a down payment on a car or a house, take a long time to achieve.
Allocating the cash back you earn from your credit cards can help you reach those goals faster. It may seem unnecessary to spend the relatively small amount of money you earn on those 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 to your regular savings can help you reach your goals a little earlier.
Invest for your retirement. Generally, the biggest impact your cash back credit cards can have is investing for your future retirement needs. “When you get cash back and invest it over the next few decades, the cash back you get today is going to multiply,” Allec explains.
This is due to the power of compound returns, which means that the money you earn by investing your cash back is added to your investment balance. Then these income can generate additional income on their own. “If you’re relatively young, let’s say in your 30s, taking advantage of these cards can be very beneficial to you,” says Bailey.
The amount of cash back you earn each year may be as low as a few hundred dollars, even if you put all possible purchases on a credit card. That said, applying it constructively rather than frivolously can make a real difference in the long run. Using your cash back in this way can turn a seemingly insignificant amount of money into a major benefit later in your life, Bailey explains.
Let’s say you earn $ 500 in cash back every year. If you invest your $ 500 in cash back this year and get a 6% annual return for the next 30 years, that $ 500 will turn into $ 2,871. If you’re even more diligent and invest your $ 500 rebate this year and each year for a total of 30 years while getting the same 6% annual return, you’ll end up with $ 44,775.
Maximize cash back rewards by redeeming for the best value for money
Some credit cards allow you to redeem your rewards for multiple options rather than just 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 special card allows you to book a trip through the Hunt the 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 possible financial position, try to maximize the value of your rewards within reason. For example, if you had an upcoming trip and planned to pay cash for the trip, it often makes more sense to redeem your rewards for the higher price of 1.25 cents per point by booking through the Chase Ultimate Rewards trip. Then take the money you would have spent on that trip purchase and put it towards the goal where you allocate your cash rewards.
Remember, Cash Back Rewards are only valuable if you don’t have a balance on your credit cards. Otherwise, the interest you pay is likely to exceed the cash back you earn. As long as you don’t have a balance on your cards, using this cash back product productively can help you prepare for a brighter financial future.