Study results show that credit card rewards are taking advantage of America’s less financially savvy people

There's a deep chasm between those who benefit from credit card rewards and those who don't, a gap from which banks appear to benefit, according to a new working paper.

Financially savvy individuals with higher credit scores were more likely to benefit from credit card rewards, at the expense of naïve consumers with lower scores, who tended to overspend to get more rewards, creating an imbalance.

As a result, the researchers of the Federal Reserve's Finance and Economics Discussion Series staff working paper estimated that $15.1 billion was transferred annually from “the less educated to the more educated, poorer to richer, and high-to-low minority population areas,” overshadowing the existing differences magnified.

For credit card holders, wise spending of rewards programs can make a difference to your financial well-being — especially when interest rates continue to rise. If you're not careful, banks can easily take advantage of your lack of knowledge, the researchers say.

“Banks…can design financial products to exploit these flaws by combining salient benefits with obfuscated payments,” the researchers said. “Naïve consumers could underestimate these payments and incur costs by using them. In contrast, knowledgeable consumers could take advantage of the benefits, avoiding the payments and thus benefiting from usage.”

“Such products can therefore cause an implicit redistribution from naïve to sophisticated consumers, thereby contributing to inequality,” they added.

An airline passenger uses a credit card to pay for items at a retail store at John F. Kennedy International Airport in New York City. (Credit: Robert Nickelsberg/Getty Images)

Cardholders with better credit were better off

Using FICO credit scores as an indicator of financial savvy, the researchers compared award card results to non-award traditional credit cards.

The analysis found that super prime cardholders (FICO score above 780) earned an average of $9.5 in rewards and paid $7.1 less in interest on reward cards than on classic cards. In contrast, subprime clients (FICO scores below 660) earned just $1.8 in premiums and paid $6.4 more in interest.

“Credit card premiums tempt sub- and near-prime consumers to overspend and then borrow too much on their credit cards,” the researchers write. “High FICO cardholders, on average, make money using reward cards, while low FICO cardholders, on average, lose money.”

A traveler walks past a sign advertising a Delta Air Lines credit card at Seattle-Tacoma International Airport in SeaTac, Wash.  (Elaine Thompson, AP Photo)

A traveler walks past a sign advertising a Delta Air Lines credit card at Seattle-Tacoma International Airport in SeaTac, Wash. (Elaine Thompson, AP Photo)

According to Dara Duguay, CEO of the Credit Builders Alliance, it's not uncommon for those with poorer credit ratings to charge additional fees as banks try to balance risk.

“This is largely consistent with what we know that creditworthiness impacts your access to available products and better products, such as those with premiums or lower fees, if any, beyond available interest rates or your available credit limit,” said Duguay to Yahoo Finance. “That's why it's important to review your report and score to see where you stand and identify actions you can take to improve your score and meet your goals.”

Do the poor subsidize the rich? Not quite, says a study

According to the analysis, the redistribution from low to high FICO consumers occurred regardless of income level.

“Credit card rewards are often presented as a ‘reverse Robin Hood' mechanism, with the poor subsidizing the rich,” the researchers write. “However, our results show that this explanation is incomplete at best.”

While the researchers found that credit cardholders with the highest credit scores benefited the most from reward cards ($20.1 in net rewards compared to traditional cards), high-income consumers and subprime FICO scores, on average, paid the most ( -$12.8).

This difference between the two FICO scores also existed among low-income cardholders.

Florida, Orlando, Little Saigon, Sticky Rice Lao Street Food, employee processes Square credit card reader, remote payment.  (Source: Jeffrey Greenberg via Getty Images)

Florida, Orlando, Little Saigon, Sticky Rice Lao Street Food, employee processes Square credit card reader, remote payment. (Source: Jeffrey Greenberg via Getty Images)

Low-income super-prime people benefited less from reward cards ($9.7), but still benefited. However, low-income subprime cardholders did not benefit, instead paying less (-$2.6) than their high-income counterparts.

As a result, high-income consumers with good credit scores benefited from reward cards largely at the expense of high-income consumers with low FICO scores.

Still, there was some correlation when it came to income and other characteristics.

When the researchers examined net earnings using specific zip code factors related to income, race, and education level, they found that “higher net earnings are associated with higher education levels, higher median income, and lower proportions of educated Black residents.”

“These results suggest that credit card premiums are a potential channel that can exacerbate existing socioeconomic disparities across regions in the United States,” the study said.

Spend wisely

Among all FICO Score groups, banks benefit more from reward cards than from regular credit cards, according to the study, although the most profitable groups are near-prime and prime cardholders.

According to the Consumer Financial Protection Bureau (CFPB), reward credit cards accounted for over 60% of all new credit cards in 2019. That year, US banks paid out $35 billion in premiums.

The CFPB also found that cardholders with super-prime scores typically paid an average of $111 in annual fees in 2020, up from $100 in 2019 — with higher annual fees often leading to higher rewards. According to the report, consumers with lower credit ratings may pay annual risk equalization fees or higher “operating costs” compared to revolving credit.

In contrast, revenue from cards held by top-scoring consumers “was typically returned to cardholders in varying degrees in the form of rewards,” CFPB researchers noted.

Woman makes an online payment to her credit card.  (Image credit: Getty Creative)

Woman makes an online payment to her credit card. (Image credit: Getty Creative)

Today, inflation and other economic hurdles have led consumers to turn to credit cards even more. Since the first quarter of 2023, credit card debt has grown to nearly $1 trillion.

One way to avoid credit card debt overload is to use rewards to your advantage and keep spending within your means.

“Focus on making payments on credit cards on time to qualify for a better product, or even let the bank or company tell you about a switch to a new product — like a credit limit increase,” Duguay said. “This can happen if they see positive payments in the past.”

According to Matt Schulz, chief credit analyst at LendingTree, working to minimize your debt is crucial — especially since some lenders may limit your credit rating if they see you as a risk.

“People in the middle [with average credit scores] “They may have a harder time obtaining credit or credit approvals than higher-risk borrowers,” Schulz told Yahoo Finance. “There's a lot of unpredictability in the market right now, and banks don't like things to be volatile. Sometimes they tend to ease things a little bit, and here we are.”

Finally, practice good spending habits, Duguay said.

“Don't open too many credit cards just because they offer good rewards,” she added. “Be patient, it takes time to improve your credit score, but if you develop good habits, your score will move in the right direction.”

Gabriella Cruz-Martinez is a personal finance reporter at Yahoo Finance. Follow her on Twitter @__gabriellacruz.

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