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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

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  |     |   Comment #1
Dont forget about state taxes. Take another 10% off reward interest for California.
  |     |   Comment #2
For me it's pretty straight forward: I make my 10/12 debit card purchases on small purchases totaling around 90-100 bucks (basically the monthly interest I earn) and keep the balance at the max (25k) for the two active reward accounts - fortunately the monthly cycles are spread apart by a couple weeks.

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!
  |     |   Comment #3
Just realized that this sounds confusing:

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.
  |     |   Comment #4
The same "threat" to close out a reward checking account can also apply to a credit card account that is used very little.  Banks can also close them out too.
  |     |   Comment #5
Another advantage to using a credit card is that you are getting a free recurring loan every 30 days (assuming you pay off your account each month).  If you spend $2000 each month, over a year's time you are basically borrowing $2000 for free...or you can keep an additonal $2000 in a savings account.  With a debit purchase, the money is deducted from your account immediately.
  |     |   Comment #6
what generally is the $ threshhold of debit card usage below which banks will threaten to close your rewards checking account?
  |     |   Comment #7
i am spending $3000/month. $50/month is spent using my reward checking debit card.

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].
  |     |   Comment #8
One thing to keep in mind, security in purchases using a credit card.  You get some protection from fraud charge via credit card, i don't believe that exists for debit cards.  Also worth considering is the non-cash benefits of a credit card.  
  |     |   Comment #10
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.
  |     |   Comment #11
The best strategy:  use reward debit card only for de minimis purchases, like 8-cent copies at Staples, or dollar menu item at McDonalds, or a dollar's worth of pay-at-pump gas.  It's pretty easy to do 10 or 12 of these a month.
  |     |   Comment #12
Cactus wrote: 

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.
  |     |   Comment #13
@Tuphat: behavior like this is exactly why the Rewards Checking accounts are struggling, why those banks cut the cap or APY and/or limit the geographical range of their offers. I sure hope the banks will be selective in their sanctioning of such behavior and recognize the ones who play by the rules, i.e., make some decent purchases to allow the bank to at least not end up too much in the red for a maxed out account.
  |     |   Comment #14
To Anonymous # 13.

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.
  |     |   Comment #15
The money that banks make from your debit card use is only a tiny part of the total profit they make off of your Reward account funds.

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:


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