The High Cost of Free Merchandise Rewards

You see them everywhere. Catalog companies offer them. So do cruise lines. And even car companies.

What am I talking about? Credit cards that offer "free" rewards. Points you can use to buy anything from a box of golf balls to a new SUV. All you have to do to collect all this free treasure is use that little plastic card.

Pretty nice of them, eh?

Remember who we're dealing with. The credit arms of these companies are in the business of buying and selling money. There's nothing kind or benevolent about them. You are entering into a straight up business proposition, and they would not offer it if they didn't have a way to generate profits from it.

I got a lesson today on just how profitable this proposition can be for the company issuing or sponsoring the credit card. It started when I called the company to see if they could offer me a lower rate on my card. I've been a model customer for years, and I've no complaints with the catalog company itself. They sell high quality stuff at reasonable prices, and they back up what they sell. They do offer a credit card with a rewards program that lets you exchange points for merchandise.

I called the service center and asked if they could lower my rate. After a few minutes of conversation, we got to the lowest number she was authorized to offer. It was about three points lower than the standard rate, and about three points higher than I could get from a card without the rewards program. When I asked the rep about that, she told me that she knew the company's rate was a bit high, but that let them offer the "free" merchandise.

Let's look at some numbers. I get one point for every dollar I charge, and a bonus point for every dollar I spend on the company's merchandise. So my reward is either 1% or 2%. On $100, I get 100 or 200 points, worth $1.00 or $2.00 towards the company's products. To get a $100 item "free", I would need 10,000 points, spending around $10,000. If I carry a balance, at best that $10,000 is costing me about 3% more than it could, or $300 if I carried that balance for a year.

Such a deal. I give them an extra $300 and they give me an item with a $100 retail price which likely cost them around $50.

It gets even better.

If you have a late payment or go over your limit, your interest rate goes up about 3% for at least 6 months. Now to get that free item with the $100 price tag (which likely cost them $50), you'll have to pony up more like $450. (The original $300 plus the extra due to the penalty rate.)

So why would anyone use one of those cards?

The only time it makes any financial sense to keep and use one of these cards is if you

a) pay your balance every month and
b) buy the merchandise you get with your reward points anyway.

Otherwise, check your options and do the math before you sign on the dotted line.

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