Credit Card Victims Don’t Pay for 100% of My Credit Card Rewards

by Kevin on September 18, 2008

I got an interesting comment on my post titled “I Like Dave Ramsey, But He Is Still Wrong“. This is from Troy:

Credit Cards exist for solely one reason. PROFIT. Not convenience, points, fraud protection, etc. Those are benefits, not purpose. The purpose is profit for the issuer. That means that a majority of users must result in a profit for the issuer, and a cost for the user.

Obviosly you already know this. that is why there are rewards and benefits, etc. It is redistribution. Most people pay, so a few can benefit, yet most think they are or will be the ones who benefit, but of course the economic model will not support that.

CC are tools, just not for the user. they are tools for the issuer, and they are unnecessary. You can accomplish the exact same thing, with the same benefits, convenience, fraud protections with a debit card, so the only reason for CC is credit, and the incorrect assumption that using one is in your benefit because you can “beat” the system.

The issuer set up the system. It is their rules. Their money. their card with their name on it. They have the control, not you. They just let you think you do.

First, I want to make sure I thank Troy for his comment and furthering the discussion in a civil manner. We can all agree to disagree, right?

The credit card nay-sayers who disagree with my stance on credit card rewards like to say that it is essentially a redistribution of wealth. The argument is that a majority of folks out there are paying ridiculous fees and interest charges and the minority get the rewards from this vast amount of money the firm earns from the “victims”.

Let’s run some math here using my American Express Blue Cash credit card.

The cash back rewards program is setup like this: up to $6,500 of total charges for the year I earn 0.5% on general purchases and 1.0% back on “bonus” purchases. Bonus purchases include grocery stores, drug stores, and gas stations.

After $6,500 in total spending the rewards jump to 1.5% on general purchases and 5.0% on bonus purchases.

Let’s assume you charge $1,000 per month on your credit card. The credit card has a 2.50% discount rate for the merchant. A discount rate is what the card company charges the merchant (grocery store) to process the card. So if I spend $1,000 per month and the discount rate is a consistent 2.50% the revenue to the company is $25 for that month.

Let’s also assume I split my charges an even 50/50 — half general purchases and half bonus purchases. Each line below is one month. So line two where it says cumulative charges is 2 months worth of charges.


  • Merchant Cost: what the merchants would pay to American Express
  • Total Charges: Total amount of charges put on the card
  • Cumulative Charges: rolling total of all of the monthly charges — but not holding a cumulative balance. That is, paying off the balance at the end of the month with easy, automatic payments. Resulting in no interest or fees.
  • General/Bonus Charges: 50/50 split of the total charges for each month results in $500 in each category.
  • General/Bonus Rewards: based on the total amount of spending (under or over $6,500) the amount of rewards that would be given based off of the $500 in general and $500 in bonus charges. After $6,500 (middle of the 7th month) the rewards jump up.



Total Charges Cumulative










25 1,000 1,000 500 500 2.50 7.50
25 1,000 2,000 500 500 2.50 7.50
25 1,000 3,000 500 500 2.50 7.50
25 1,000 4,000 500 500 2.50 7.50
25 1,000 5,000 500 500 2.50 7.50
25 1,000 6,000* 500 500 2.50 7.50
25 1,000 7,000 500 500 5.00 15.00
25 1,000 8,000 500 500 7.50 25.00
25 1,000 9,000 500 500 7.50 25.00
25 1,000 10,000 500 500 7.50 25.00
25 1,000 11,000 500 500 7.50 25.00
25 1,000 12,000 500 500 7.50 25.00
300 12,000 6000 6000 57.50 185.00

* = in the middle of the 7th month the rewards change after $6,500 in spending is reached. I split that month in half — $250 for each category for the first half of the month, and $250 for each category in the second half of the month.

So let’s look at the result. The merchant would end up paying $300 to American Express. That’s a business expense and I’m sure they wish it were less, but you don’t see many stores not accepting credit cards these days. It’s the cost of doing business.

The total amount of rewards is $242.50 for the year. You can see the breakdown above. With total revenue from the merchant of $300, that leaves $57.50 for American Express. At the end of the day the total merchant costs from my spending can pay for the rewards I earn.

Some Additional Points:

  • For the average person they are going to have more general purchases than a 50/50 split. I would guess it is more like 70% general/30% bonus because big stores that sell groceries and fuel (WalMart) don’t count as bonus purchases. Restaurants don’t count as bonus purchases. This means less rewards paid out and thus more margin for American Express than the above example.
  • Some of you will say that $57.50 is not enough profit for American Express, so they must be taking advantage of someone else. This is just an example to show that my rewards aren’t necessarily coming from other user’s interest charges. I also think AMEX’s merchant charge is higher than 2.50%, but I can’t find verifiable information on that.
  • Some of you will say they also earn a ton of money from interest charges and fees from people who carry a balance. I’m not discounting that. It’s true. If you borrow money from the bank and don’t pay it back immediately, you pay interest. That’s the problem with carrying a balance. But the idea that the people who get “screwed” with credit card interest are financing my cash back isn’t 100% accurate. The merchant costs can pay for the cash back fairly easily.
  • What if more of my spending was in the bonus category? Then I suppose it might not break-even with the merchant costs. Then again, if I only spend $500 per month on bonus items and $0 on general items then it is going to take a long time to get to the tier limit ($6,500) where the really good cash back kicks in. The $500 in spending would result in $12.50 in merchant costs, and in the first tier only $7.50 in rewards. Still covering the cost of the rewards at that point.
  • Some of you may also say I am just creating this example so I won’t feel guilty about other people paying interest to American Express so I have rewards. While I wish they wouldn’t pay interest (kind of the purpose of this blog!), I am all for personal responsibility. No one is holding a gun to their heads to make them swipe the card.

So let’s hear it. Do you agree? Disagree? See some glaring issue with my assumptions? Remember, let’s keep it civil in the comments.

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Shaun Carter September 18, 2008 at 4:04 pm

American Express has one of the highest merchant charges in the industry, from what I remember when I had my business it was around 4-5% of the transaction. But statistics show that AMEX cardholders spend more than any other.

I still don’t understand how the anti-credit card people have a leg to stand on anymore. In regards to using Debit cards instead of Credit cards, like Troy mentioned, I can say I will NEVER use a debit card. I used to work in a bank and had several people have their debit card numbers compromised and lost everything in their account and the banks typically take at least a week to sort it out with their security department before reimbursing the customer anything.

With my credit cards I don’t have to worry about money disappearing from my bank account and having to plead with my bank to get it back. Instead I simply dispute any unauthorized charges on my CC and I never have to pay them in the first place.

Seems like common sense to me…

Alison @ This Wasn't In The Plan September 18, 2008 at 5:21 pm

Great article!
I’ve always thought that it was the merchant fees that were funding my rewards and have never once felt like it was others’ interest fees that made the rewards I love so much possible. It just makes sense to me that way. The money that Discover earns from merchants when I make purchases is very, very small, but I’m sure they still like it.

Kevin September 18, 2008 at 7:07 pm

Also, for the pro-debit card folks… debit cards also cost the merchant. Perhaps not 3% or more, more in the 1-1.5% range… but debit cards DO profit the banks. Gasp!

Paige September 18, 2008 at 8:59 pm

The card companies like Visa or Mastercard have arrangements with companies that give you the rewards too.

So if you are using a Mastercard to book a Delta airline ticket and you get certain miles, it is because there is a contract between Delta and Mastercard too.

It’s not cool to try and make people feel guilty when they earn rewards on their CCs because someone else is not responsible with their money.

Soren September 19, 2008 at 12:02 am

How much does the merchant pay in fees to accept cash?

Any additional costs incurred in the supply chain eventually cost the consumer. We pay for those rewards through increased price points from the merchants, who can’t afford to allow their profits to dip too dramatically as a result of increased use of plastic.

The question is not so much one of rewards and other nifty incentives from the credit card companies (which are based on appeals to emotion) but of security: I DO tend to feel more secure with a piece of plastic in my wallet instead of $300 in cash. That being said, I pay for the security—although it is often well-covered by a sweet layer of I’m-flying-to-Vail-frosting so it goes down smoooooth.

Kevin September 26, 2008 at 11:59 pm

@Paige: Exactly, Discover does the same thing with rental car companies (and I’m sure hundreds of other merchants).

@Soren: The only problem I have that idea is that you would pay it anyways. Seriously. Me not using a credit card has 0% impact on the companies that accept them (and pass the costs on).

It’s become a standard business expense and people just have to adapt.

I also agree on the security. Those cash-envelope people are nuts 😉

Jc October 1, 2008 at 7:44 pm

You are actually perfectly correct. Interchange fees completely pay for rewards. On the higher level in the bank, You can consider it two separate categories for accounting. Interchange fees offset rewards paid, Interest paid on credit cards(Interest Income) are offset by money paid on “loans”(either from other banks or depositors, IE, Interest Expense)

When implementing these rewards programs(which are now available on many debit cards, the bank I work for currently offers a dime for every time you use your debit card to purchase anything over $1. This adds up if you use your debit card a lot for smaller purchases. I buy a soda every day(so unhealthy) for $1.37, I get a dime. If i do that 365 days, I spend 500, but receive in rewards 36.50. That’s a 7% rewards rate.

BTW, Discover and AMEX are the two most expensive cards to accept, and can sometimes cost up to 8%. Most other costs aren’t much below that. 2.5% would be much closer to what Visa/Mastercard charge for a keyed in card(the most expensive way to process a transaction)

As a side note about debit cards. A compromise is about as frequent as with credit cards. The process may be different but that is because we are talking about cash, not a loan. The liability limits are essentially the same. I’ve banked with 6 banks in my life, and I’ve worked at two, neither that I’ve worked for ever made you responsible for a dime and one of the ones I’ve banked with did not either. The other 3, I can’t speak for, never had that problem.

Those that claim debit cards bearing a visa/mc logo are not as secure as credit cards obviously do not understand that both use the same network, both use the same plastic(basically) and both are treated the exact same way by a merchant.

If someone finds your credit or debit card, they can get pretty much whatever they want. It’s not very often someone verifies the signature, or even if you write see id, that’s often overlooked. It’s a fact of life(PS. Not signing your card is the absolute stupidest thing you could do because what if in the off chance someone does get your card and signs the bank and the clerk verifies the signature? Hmm, If the crook signed your card for you, guess what matches? The Signature).

Kevin October 3, 2008 at 9:34 pm

@JC: Thanks for verifying the information about the rewards vs the costs. I guess if you did a lot of small transactions then the debit card might be a good option. You might also calculate the difference in “floating” your credit card balance in an online savings account.

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