Freeloader. Mooch. Deadbeat.
You'd never want your bank to call you any of these names. However, after a series of financial reforms that has upended the banking industry, lenders can't wait to issue some of their most prestigious credit cards to deadbeats.
As Inigo Montoya might have said if he were a banker in "The Princess Bride," the word "deadbeat" does not mean what you think it means. As reported by the 2004 PBS Frontline documentary, "The Secret History of the Credit Card," executives at major banks assigned the nickname to customers who paid their credit card balances every month.
Instead of rewarding these responsible, conscientious cardholders, some lenders hiked their interest rates and annual fees. After all, most lenders made the majority of their profits from finance charges on revolving accounts. Using a credit card just for the perks left banks on the hook for profit-sapping rewards.
Then, the Credit CARD Act of 2009 forced banks to rethink their business models and operate with more transparency. Other new regulations required banks to de-leverage, leading to lower credit limits for many borrowers.
When banks have too much cash on hand, they end up paying a premium to the Federal Reserve. To keep regulators, shareholders and accountants happy, lenders extend cash back credit card offers to low risk borrowers who can pay down balances relatively quickly.
According to research by the Pew Charitable Trusts and Mintel Comperemedia, the best way to attract a customer with a high FICO score is to offer cash. The same customers banks tried to fire 10 years ago have turned into hot properties for today's consumer lending portfolios.
How deadbeats make money without robbing the bank
Instead of making all of their profits from finance charges, lenders now pull significant revenues from transaction fees that can rise as high as 4 percent. During recent legislative hearings regarding debit card transactions, 7-Eleven and other retailers suggested that lower interchange rates would lead to lower prices at the checkout counter.
Yet, representatives from the American Bankers Association and other industry groups cited a lack of evidence that merchants would reduce prices for consumers if processors capped their rates.
If you take everyone's statements at face value, banks say that merchant fees pay for customer service and fraud prevention. Retailers say that they would give you the money if they could. Therefore, becoming a deadbeat on your rewards credit cards honors everyone's intentions by returning some of your own cash back to your wallet.
Once you've got a great cash back rewards card, you'll want to maximize your earnings by using that card for as many transactions as possible. The most successful credit card deadbeats use their cash back cards almost like debit cards, budgeting cash from a checking account to pay down balances.
Combine your deadbeat habit with a high interest savings account, and you can even earn some interest on the money you've set aside to pay your credit card at the end of the month.
How deadbeats make the most of cash back cards
Mintel's research shows that almost one in four American credit card offers includes some kind of cash reward to entice new applicants. Retailers sometimes shy away from AmEx's high merchant fees, but the company provides some of the most generous cash back cards on the market.
American Express, Chase and Capital One feature industry-leading websites where you can track your rewards balances and claim your rebates. Capital One and American Express will convert your reward points into statement credits once you've earned $25. Chase will let you redeem your points for credits or checks with as little as $20 on the books.
Of course, credit card companies aren't content to scrape by on their share of interchange fees forever. If you miss a monthly minimum payment or if you go over your credit limit, you'll probably forfeit your reward credit along with your low APR and your high credit score. Therefore, it's wise to follow a few precautionary steps when using cash back credit cards:
Monitor your transactions on your lender's website. Report any problem charges quickly, so you can prevent identity theft without losing the use of your favorite card.
Request reward credits as early and as often as possible. Capital One's system will even let you automate the process, at the $25 reward level.
Don't treat rewards like a bank account. Your rewards can disappear at almost any time, for almost any reason.
Multiply your rewards. Most banks will double or triple your earnings if you convert them to a retail partner's gift card or merchandise credit.
Pay your bill online. Don't risk your rewards on a lost envelope.
Becoming a credit card deadbeat takes discipline. After all, it's tempting to let a large purchase ride on the credit limit you've earned from your favorite lender. Just remind yourself that you're enjoying the security of knowing that you've got cash set aside for everything you're buying, and that you get to squeeze a few extra pennies from every dollar you spend.