Cashback and what they aren't telling you

In the world of credit cards, (some) debit cards, and corporate cards, the allure of cashback is harder to resist than an ice-cold shower after a heavy leg-day at the gym.

Earning a percentage of your spending back as cash can seem pretty shrewd, or even unique.

There’s a but.

How can card issuers (the banks and fintechs behind them) actually afford this?

Can they? Sustainably?

What’s the catch?

If you’ve ever asked yourselves these questions, you’ve come to the right place.

Let’s dive into the mechanics of cashback rewards and uncover how issuers sustain these programs, how they find other ways to profit off you, and how you can stop them by reducing the net cost to yourself or your business.
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How do issuers make money off cards?

First, let’s understand how exactly card issuers make money off the cards they give you.

Whenever you swipe your credit or corporate card, the merchant pays a fee to the card issuer. This fee is called the interchange fee, and typically ranging from 1.5% to 3% of the transaction amount. It is also a significant and prized revenue stream for card issuers. Almost too prized.

You may not have known this, but the interchange fee is also shared amongst several entities in the ecosystem. This includes schemes like Visa, Mastercard, and AMEX and other tech companies in the chain.

How does cashback work?

Cashback cards offer a percentage of your purchases back in the form of, well, cash.

Typically, this ranges from 1% to 3%, depending on the card and spending category.

For example, a card might offer 1% cash back on all purchases but 5% on groceries or gas during a promotional period.
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Hang on, isn’t +1-1 = 0?

If you’re good at math, you would have noticed that the income made by issuers (1.5 - 3%) from fees equals the cash given back to you (1-3%) from the cashback program.

How is this sustainable?

Spoiler: It’s not.
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How card issuers sustain cashback programs

Often times, cashback programs are temporary promotional gimmicks used to get you in as a customer.

On the P&L of the issuer, they are treated as an “acquisition cost” — the cost of acquiring you as a customer. Instead of spending money on online ads and billboards, they spend money on cashback programs. Some even spend money on both.

The hope is that, once the promotional cashback period ends, you are too lazy or “stuck” to leave (a concept called customer or logo retention).

This is an age-old good strategy, and has worked across multiple businesses for decades.

There’s another but.

Sometimes — and especially when cashback programs appear to never end — there is more at play. And you should be very weary when this is the case.

There are three main ways that cashback programs are sustained profitably today:

• Interest Charges: If you carry a balance on your credit card, you’re likely paying interest rates that can be quite high—often around 15% to 25%. These interest charges are a major source of income for issuers and help fund cashback rewards.
• Annual Fees: Some cashback cards come with annual fees. While these fees can be offset by the rewards for heavy spenders, they contribute directly to the issuer’s bottom line.
• Foreign Transaction Fees: When you use your card abroad, issuers often charge a fee for currency conversion. This fee typically ranges from 1% to 3% of the transaction amount. This is likely the most controversial and hidden method of making money out there. Why? It requires deep knowledge and awareness on FX (foreign currency exchange) rates and a detailed analysis of your card statements each month. The hope from issuers is that your attitude towards this level of due diligence is: “Ain’t nobody got time for that.”

How to avoid FX fees

FX fees are far more difficult to negotiate away. Especially when you card issuer offers you cashback. Try it. You’ll immediately fail.

Why is that? It's a highly lucrative revenue source they don't want you to know about.

FX fees are usually ridiculously high. Often times, as much as 3% per transaction.

Imagine the issuer making +1.5% on interchange, +3% on FX fees, and then “rewarding” you with a measly 2% cashback.

Another solution here is to find a card issuer that makes money in other, more transparent, ways. There are plenty out there.

How to avoid annual fees

Annual fees can almost always be negotiated away. Banks and fintechs charge these to offset any rewards they give you. More often than not, the interchange fees you pay your bank or fintech are higher than the annual fee they charge you, so they’re happy to waive the fees, “just this one time”. I’ve been getting “just this one time” annual fee waivers for the last 12 years.

How to avoid interest

Obvious one: Don’t spend more than you can afford to each month

Another obvious one: Pay your card on time. Set reminders on Calendar. Set up automated card repayments with your bank so you never forget about it again

Never carry a revolving balance on your credit cards.

Know the annualized interest rate you’ll be charged for late payments. Then, either be okay with it or find another way to “borrow” cheaply.

Know the fee for missed credit card payments and be okay with it.
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Conclusion

Find as many credit card and corporate card deals as you can. But always analyze the fine print behind each of them.

Always question how your card issuer makes money off you. Ask yourself how they are going to sustain their own business. Do you want a card issuer who’s going to eliminate the cashback offering in a few months, and force you to change cards?

Find an issuer that is both fair and will last.

Things to ask your card provider/issuer to keep them honest:
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What is your Foreign transaction (FX) fee on international spends?
(Hint: It should be zero).

What FX rates am I paying for USD-AED conversion?
(Anything above 3.78 means you're paying more than 3% per USD transaction)

What do I pay in annual subscription fees for my card?

What is the late payment fee (if any) on my card?

What is my interest rate on overdue payments?

What are the prerequisites or fine print on your cashback program?

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Cashback credit cards and corporate cards can be a valuable tool for savvy consumers, but it’s crucial to understand how issuers fund these rewards and where they might be making up for their generosity.

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