Reward Checking Yields vs Cash Back from Credit Cards - Which is Better?
The main downside to reward checking accounts is the debit card usage requirement. The typical requirement is 10 debit card purchases per month to qualify for the high interest rate. For those who have cash back credit cards like those from Charles Schwab, Fidelity or PenFed, every time you use a debit card, you lose out on some cash back. One common strategy is to make big purchases using the cash back credit card, and then use the debit card for smaller purchases. For those who want to keep things simple without switching back and forth, the question becomes which will give you the most rewards: the reward checking account or the cash back credit card?
The best rewards will depend on how much you spend and how much savings you have that you want to keep liquid and safe. I thought it would be interesting to compare some different spending and balance scenarios.
In the comparison I list the credit card cash back rewards from spending a certain amount per month. I'll assume a 2% cash back rewards. You can sometimes do better than this with certain cards in certain categories, but it's rare to go above this for all categories.
For reward checking accounts, I'll assume that you are receiving a reward checking rate that's 2% higher than what you could have received if you just had used a high-yield savings account. This rate spread could be higher if you're comparing the 4.09% reward checking account at Bank of the Sierra vs. ING Direct's 1.10% savings account. But for simplicity, I'll just use 2% which is a reasonable estimate based on my experience.
One thing that helps credit card cash back rewards is that it's generally believed that credit card rewards are not taxable income. However, the higher interest from reward checking accounts are fully taxable. In the comparison, I assume a 25% tax bracket.
Yearly Earnings from a 2% Cash Back Credit Card
Monthly Purchases | Yearly Cash Back |
$500 | $120 |
$1,000 | $240 |
$2,000 | $480 |
$4,000 | $960 |
Extra Yearly Earnings from a High-Yield Reward Checking Account
Checking Balance | Extra Yearly Interest | After Taxes (25% rate) |
$10,000 | $200 | $150 |
$25,000 | $500 | $375 |
$50,000 | $1,000 | $750 |
$100,000 | $2,000 | $1,500 |
So if you spend $2,000 a month, you'll earn $480 cash back assuming a 2% cash back credit card. If you have $25,000 in liquid savings and replaced all of your credit card purchases with debit card purchases, you'll make an extra $375 from the reward checking account over a high-yield savings account. So you'll be better off keeping your $25K in a high-yield savings account and using the cash back credit card rather than switching to the reward checking account.
However, if you only spend $1,000 a month, you'll earn $240 cash back. The $25,000 balance in the reward checking account will allow you to earn an extra $375. So for this case, the reward checking account is the better option.
As I mentioned above, those who are willing to spend the time will want to use the cash back credit cards for big purchases and the reward checking debit cards for the smaller purchases. One thing to keep in mind is that some banks have threatened to close accounts for those who were not making enough purchases per month. So it's best not to reduce your debit card purchases by too much.
Are the benefits from reward checking accounts big enough for you? How much rate spread do you require over the best high-yield savings accounts? How do you optimize using cash back credit cards and reward checking debit cards? Please share your experience in the comments.
High-Yield Reward Checking Account Resources
All the other purchases, bigger ones are made with various cashback credit cards.
So I figure that missing out on a total of about $200 in cashback because I use a debit card would give me all of $4 bucks in cashback (2% average) - no comparison to what I get from my rewards accounts for using the debit cards!
So I figure that missing out on a total of about $200 in cashback because I use a debit card would give me all of $4 bucks in cashback (2% average)
It's $200 in purchases that I could get 2% cashback which I miss out by using the debit cards.
i charge $2950 each month to my cash back (1%) card. i earn $354[taxfree] for the year.
i hold each month's $2950 installment in my rewards checking account (5%) at the beginning of each month for 30 days. i earn $148[taxable] for the year. i am actually able to deposit $2950 each month and hold it for 50 days boosting my effective earnings to $246[taxable] for the year. the extra holding period is made possible by paying the cash back card with another credit card.
effectively a constant $2950 on hand for the year is yielding $600 20%[less than half taxable]. 12%[taxfree] is attributable to not paying credit card interest and 8%[taxable] is due to holding on to the funds as long as possible.
and of course i try to maintain the full $25k in rewards checking, or $22050 earning $1103[taxable].
These games are coming out of the hide of the merchant who, in turn, has to raise prices to cover the debit card transaction fees.
The merchant never really lose. They just pass on the cost of doing business to the consumer. In the end, we're all paying for it with increased cost of merchandise. But since the merchants are raising prices anyway, I might as well play the game, as opposed to entirely sitting out of the game by paying cash for merchandise already priced with credit card prices.
If the transaction amount is an issue, they can change the program requirements to state that only debit card transactions that exceed a certain amount will count towards meeting the program guidelines for maintaining the reward rate. So the small transactions can still be done, but not count towards the program requirements. Some merchants don't accept credit cards until your charge total exceeds a certain amount. Same rule could apply to reward checking.
The profit that banks earn by using your money for bank investments and loans is by far the highest profit margin of a Reward account.
The second highest profit is from insufficient funds fees.
Then the distant third highest profit is from collecting debit card fees.
Profit is also gained by reduced customer support costs, such as electronic rather than mailed statements. According to BancVue, Reward Checking customers create 4 times more bank profit than Free Checking customers.
These numbers are according to BancVue's Reward Checking Profit Summary:
http://bancvue.com/cb/downloads/REWARDChecking_BK.pdf