Who pays for your credit card rewards and why do banks offer them? A report by the Federal Reserve.

[IsambardPrince]

Essentially the rewards systems benefit the credit card banks or they wouldn't do it. They encourage customers to spend like mad on their cards, spend too much, owe the bank interest, or at least make the merchants owe all these fees.

Then prices go up at merchants to fund credit card rewards for people who can get them, and people who have to pay cash because they're broke and living on the fringes of society lose money to fund card rewards for richer people.

This isn't just me saying this btw, here's a report from two years ago by the Federal Reserve, the central bank of the United States.

https://www.federalreserve.gov/econres/feds/who-pays-for-your-rewards-redistribution-in-the-credit-c...

"Abstract:

We study credit card rewards as an ideal laboratory to quantify redistribution between consumers in retail financial markets. Comparing cards with and without rewards, we find that, regardless of income, sophisticated individuals profit from reward credit cards at the expense of naive consumers.

To probe the underlying mechanisms, we exploit bank-initiated account limit increases at the card level and show that reward cards induce more spending, leaving naive consumers with higher unpaid balances.

Naive consumers also follow a sub-optimal balance-matching heuristic when repaying their credit cards, incurring higher costs.

Banks incentivize the use of reward cards by offering lower interest rates than on comparable cards without rewards. We estimate an aggregate annual redistribution of $15 billion from less to more educated, poorer to richer, and high to low minority areas, widening existing disparities."

In other words, they drive people to spend more than they should, chasing itty bitty teeny weensy little airline miles, and then they pay outrageously high interest, and if they do pay it off most of them don't pay off their cards in the ideal order (debt avalanche, highest to lowest interest), and it sends $15 billion dollars a year from the poor to the rich, the less educated to the more educated, and from racial minorities to Whites, "widening existing disparities".

What's more, the banks will initiate "Credit Line Increases" more for customers they feel are likely to get themselves in a lot of trouble.

The Fed even says that banks tend to charge less interest on rewards cards than non-rewards cards to further incentivize customers to pick rewards cards. In the detailed paper, it also says that while the average interest rate of rewards credit cards is lower, for low FICO customers it is higher, therefore, causing low FICO customers with scores below 720 to go ahead and lose money every month, on average due to this additional interest and the fees, even with rewards credit cards, while Prime and Super-Prime customers earn quite a bit of money.

Why is it even legal? Well, frankly I think it shouldn't be, but banks have a lot of lawyers and lobbyists and poor Black and Brown people don't, and neither do poor people in general for that matter. And neither do other marginalized communities, such as the LGBT community, which the Human Rights Campaign says is significantly more likely to experience poverty.

See; https://www.hrc.org/resources/the-wage-gap-among-lgbtq-workers-in-the-united-states

Thus, while the banks insist there is no systemic racism and homophobia and transphobia in their institutions, the Federal Reserve and HRC studies seem to imply otherwise.

While we're here anyway, it's worth noting that a significant number of transgender individuals have even had issues getting their banks to stop deadnaming them on their accounts and credit cards, even after legal name changes, according to CNBC Make It, and have also faced issues trying to get their credit reports updated.

https://www.cnbc.com/2024/05/02/name-changes-can-create-financial-chaos-for-transgender-americans.ht...

Many people who wouldn't otherwise consider using a credit card get one so they can "build credit", but then the only thing they actually end up needing with the credit is a job or an apartment, which didn't even used to require a credit score, and still doesn't in some cases, and in certain parts of the country.

(Mostly the ones like the part of Indiana I came from where almost everyone is broke and has bad credit anyway, and non-traditional finance like rent-to-own housing contracts are about as common as bank mortgages. This usually works out because houses are cheap there anyway and not dealing with a bank greatly simplifies the arrangement. Since the landlord can evict people who don't pay quickly, his or her risk is minimal and if people decide to move, they can get the part that went into the purchase back with interest from the landlord. This sets up a system where people marginalized by the credit score system can still function in society.)

So who pays for this? The people struggling with credit card debts, people who can't get rewards credit cards because they're poor and have bad credit, and people who are too "unsophisticated" to figure out how to manage reward categories.

It's pretty much utterly despicable that this goes on. It's not fair. And here you have the Federal Reserve reporting that Dave Ramsey is right, all except that Ramsey promotes debt snowball if you're in credit card debt, saying that paying off debts from smallest to biggest while minimum payments go in on everything else then re-allocating the money from the smaller ones to bigger ones until it's all paid off is better.

Ramsey concludes that the savings from debt avalanche is not worth the dismal "20%" success rate, compared with "80%" for snowball, and he concludes that it's better to pay the extra interest because it won't be much different either way and most people are not math nerds.

"If you go on a diet and don't lose some weight in a few weeks, you give up."

I can see the logic.

Anyway, here's the entire paper on credit card rewards and how they're upwards wealth distribution (with the banks taking a lot more for themselves, naturally).

https://www.federalreserve.gov/econres/feds/files/2023007pap.pdf

A 70 page paper highlighting why banks do credit card rewards and what they're actually "rewarding" you for.

tl;dr They hope you'll mess up big time, get ahead of yourself, and owe them a LOT of money. If it takes them years, then it will still be worth it when you do.

[NoMoreE46]

While there is a huge disaparity between the profile  an Indigo card vs a Centurion card holder, there is the basic premise that both card holders pay their balance in full 
Or be subject to whatever respective Interest there will be assessed the following month.

[redpat]

I could care or less who pays for mine as long as I get them.

Thank you, everyone......Doh, Banks offer rewards because their cards wouldn't get any use if they didn't have them.

[check102]

The simple solution to me is a legal cap on all unsecured loans (like credit cards), at 15 or 20 percent. A serious anti-usury law. Usury is considered a sin because a financier is collecting payment without providing any tangible service that is a positive economic value, and simply redistributes assets for no real business reason other than the loan contract says so.

Another real maybe-politically-feasible solution is to limit interchange rates for small businesses, but that doesn't stop the predatory credit card/personal loan business to poor consumers.

Ultimately, banks and private finance run this country and are more or less untouchable until the music stops.

[Aim_High]

In many ways, this is nothing new to the discussions on My FICO from the past about rewards programs.   Obviously, banks wouldn't (can't) offer rewards if they aren't getting something out of it, as they operate to make a profit. This is a capitalist society, like it or not.  While the bulk of that 70 page paper discusses the transfer of wealth from the financially-naive to the financially-sophisticated, the authors made a point about drawing racial and socio-economic conclusions at the end.   The play to turn this into a racial inequality proposal is rather disturbing since their paper also reports on page 29: 

"Columns 2,4, and 6 illustrate that all coefficients become statistically insignificant and close to zero in magnitude when controlling for a ZIP code’s average FICO score, indicating that differences in financial sophistication are the underlying mechanism driving our geographical results."  

In other words, this research appears to me to be a verdict on the lack of financial literacy and education in this country.  FICOs do not discriminate by income or race and in today's information age, there is a wealth of assistance to anyone who cares to learn more about it. 

By the way, the slant of OP's posting is dancing all around the My FICO terms of service, which prohibit discussions involving race, nationality, sex, religion, politics.   I could easily see this discussion diving off into controversial territory and we don't do that on these forums. 

The article categorizes FICO by sub-prime, near-prime, prime, and super-prime.  In a nutshell, lenders make more money from cardholders in the sub-prime, near-prime, and prime categories.  However, FICO score is essentially a RISK score for financial institutions on how likely they are to be repaid.  Consequently, the losses on that same range of scores is also higher than for super-prime even though the lending costs for the consumer is higher.  That's just the way the game works.  Sure, the banks charge more than they need to cover their losses to make sure they don't lose their shirt.  Super-prime consumers end up profiting.  But anyone can become prime or super-prime with enough financial education, discipline and responsibility. 

Life isn't always fair and it never will be.  Learn the rules and play by them, or choose not to play the game. 

[IsambardPrince]

---

@check102 wrote:

The simple solution to me is a legal cap on all unsecured loans (like credit cards), at 15 or 20 percent. A serious anti-usury law. Usury is considered a sin because a financier is collecting payment without providing any tangible service that is a positive economic value, and simply redistributes assets for no real business reason other than the loan contract says so.

Another real maybe-politically-feasible solution is to limit interchange rates for small businesses, but that doesn't stop the predatory credit card/personal loan business to poor consumers.

Ultimately, banks and private finance run this country and are more or less untouchable until the music stops.

---

The Supreme Court ended this when they decided that State usury laws didn't apply if the bank headquartered in States that don't have one, or have a lower one.

That's why Indiana's cap at 23.99% rarely applies and no major banks are legally headquartered there.

They go to Nevada, South Dakota, Delaware, etc. This is why. Then they can just keep sending you a notice whenever they feel like it that your interest rate is going up another 300 basis points. (Synchrony)

[NoMoreE46]

Google  Tribal Loans.  

[IsambardPrince]

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@NoMoreE46 wrote:

Google  Tribal Loans.  

---

Those fall under a different thing entirely.

The tribes claim that since they aren't part of the State to begin with that it doesn't even matter what State they're in.

Some even go so far as to do things illegal under federal law too and claim there's no federal law saying they can't. (Sovereign Immunity)

So the Tribal Loans are worse. And sometimes it's not even the tribe doing it. It's people doing "rent a tribe". You can fund tribal loans and the tribe is technically not the source of the funds. Who even knows who does it? Could actually be the mafia.

[NoMoreDebt]

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@Aim_High wrote:

In many ways, this is nothing new to the discussions on My FICO from the past about rewards programs.   Obviously, banks wouldn't (can't) offer rewards if they aren't getting something out of it, as they operate to make a profit. This is a capitalist society, like it or not.  While the bulk of that 70 page paper discusses the transfer of wealth from the financially-sophisticated to the financially-naive, the authors made a point about drawing racial and socio-economic conclusions at the end.   The play to turn this into a racial inequality proposal is rather disturbing since their paper also reports on page 29: 

"Columns 2,4, and 6 illustrate that all coefficients become statistically insignificant and close to zero in magnitude when controlling for a ZIP code’s average FICO score, indicating that differences in financial sophistication are the underlying mechanism driving our geographical results."  

In other words, this research appears to me to be a verdict on the lack of financial literacy and education in this country.  FICOs do not discriminate by income or race and in today's information age, there is a wealth of assistance to anyone who cares to learn more about it. 

By the way, the slant of OP's posting is dancing all around the My FICO terms of service, which prohibit discussions involving race, nationality, sex, religion, politics.   I could easily see this discussion diving off into controversial territory and we don't do that on these forums. 

The article categorizes FICO by sub-prime, near-prime, prime, and super-prime.  In a nutshell, lenders make more money from cardholders in the sub-prime, near-prime, and prime categories.  However, FICO score is essentially a RISK score for financial institutions on how likely they are to be repaid.  Consequently, the losses on that same range of scores is also higher than for super-prime even though the lending costs for the consumer is higher.  That's just the way the game works.  Sure, the banks charge more than they need to cover their losses to make sure they don't lose their shirt.  Super-prime consumers end up profiting.  But anyone can become prime or super-prime with enough financial education, discipline and responsibility. 

Life isn't always fair and it never will be.  Learn the rules and play by them, or choose not to play the game. 

---

Well said and I had the same thoughts when reading the OP's slant.

[IsambardPrince]

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@NoMoreDebt wrote:

---

Well said and I had the same thoughts when reading the OP's slant.

---

The Federal Reserve paper did mention racial disparities. And it would be disingenous to talk about poverty without mentioning a few facts about who is in poverty, and thus tends to be marginalized by banks and FICO whether there's any racial or other biases in the score or not, there certainly are by proxy. It's a way for banks to still say "no" to customers they don't allow in their establishments, but to paint a fig leaf over all of the pain and suffering they've caused over the years which continues to play out, by saying some score said so.

Disney World used restrictive covenants in their agreement with the Reedy Creek District before they lost control of it. But what nobody does say is why restrictive covenants were ever entered into the law to begin with, it was a tool to enforce redlining by the banks by throwing it into the deeds to homes so that people afflicted by discrimination couldn't even try to buy the house.

Years after all the damage was already done, the State of Illinois passed a law allowing homeowners to remove those covenants from their deeds, but they've been unenforceable under Federal law anyway since the Fair Housing Act.

The banks essentially moved quickly and did everything they wanted to do while they could still admit why and how it was being carried out, and now they have a credit score that says "Who knows why that happened? It's not you, it's the score!"

We all know the score. These are not controversial statements, it's a well recorded historical narrative documented by peer-reviewed research.

In fact, the government of Illinois openly admits what is going on but it doesn't do anything substantive to correct the imbalances.

If the situation with FICO scoring gets much worse, about the bottom 20% won't even be able to get a library card.

I'm glad to see that Illinois is considering getting credit scores out of the car insurance industry. Making someone's insurance expensive just because they've had financial difficulties is basically just punative, and it's designed to punish them for dealing poorly with some unpaid credit cards by making it more likely they have to drop their insurance and end up getting arrested.

The Big Problem with Credit Scores - CNBC

What Capital One doesn't want you to know. -More Perfect Union

"We're talking about underwriting up to a point where one in three people will default and then get sued." -Elana Botella (Former Capital One Employee/Analyst)

This is what your FICO score really means. -Dave Ramsey

If you don't believe Dave Ramsey, believe Rocket Mortgage. They are a mortgage originator, so here's what they say about FICO scores. (Emphasis mine.)

https://www.rocketmortgage.com/learn/what-is-manual-underwriting-and-how-does-it-work

"Paying back debt is the foundation of a great credit score. But if the borrower chooses to live without debt, they might not have much of a FICO® This doesn’t mean that they have bad credit – just that they have no credit at all. If this is your situation, your lender will need to manually consider your repayment ability."

There you have it. Paying back debt is how you get a FICO score. It says nothing else about you except you pay debt and you pay a lot of debt and eventually you pay a lot of interest, interest builds hundred story bank towers on the skyline with nicer furniture than you have, because they used your money when you went and got a car loan and added $10,000 of "not car" to your car, etc.

You can get by without a FICO score. I did it for over a decade. I didn't know there even was one. I lived debt free. Didn't even have a FICO score.

Anyway, if FICO's standards are high, I wonder how there's basically so many "buy yourself a credit score" products out there like those credit builder loans, and secured credit cards which aren't a risk to the bank because it's not really debt so much as "He just got denied an apartment so we'll put him on this credit builder loan where we just take payments and $20 a month from him, and now he qualifies for a mortgage!"

Okay, so the bank opens a CD account you can't touch until you make the payments, meanwhile they get $20 a month from you to pay them, and then they give you the money back except the payments and now your credit score is suddenly better to the point where you can get a mortgage, even though that wasn't actually a debt product with any risk. They just sold you some FICO points.

What is this? It reminds me of some crappy freemium game on an iPad.

When I had some life problems years ago and emerged from bankruptcy a little smarter and a lot angrier than I was before, my attorney recommended a credit builder loan and I said, "What's that?" and she explained it to me and I said, "What, so I'm supposed to buy FICO points? That sounds dumb to me. I'll find some other way."

We have a FICO score that supposedly gauges risk and we have some sort of what appears to me to be a "pay to cheat" system?

You know when people aren't any good at a video game so they just take money (on a credit card usually) and they buy things in the game to make the game easier, for money. That's really all this strikes me as.

Instead of engaging with these "pay to play" antics over "points", put that $20 a month you'd spend on the "credit builder" to work. Or buy some food with it. Or save it up so you can pay actual bills so they don't end up in collections this time.

Then I ran into a product the other day that's a $99 a year checking account with a "debit" card that's actually a "credit card", only you can't make payments because everything you charge today comes out of the account tomorrow and you can't default on it.

So we're past the point of stupidity here, and into "buying a credit score", which doesn't predict risk because anyone with the $99 a year can buy their way into a FICO score without being able to mess up.

So saying FICO predicts risk with products like these out there does not convince me. It predicts that one way or the other, through debt interest or paying someone to say nice things, you'll have a credit score.

"For $99 a year you'll have a credit score. For $240 a year we'll make it look like you're diversified into installment loans. With a deposit for this secured credit card we'll issue you a product with no risk to us."

I mean, it's pretty obvious what this is, and the fact that FICO even allows the bureaus to report on these sorts of products seems to me to be pretty telling.

A risk score would only factor in products with a credit default risk. Not all sorts of things where you pay to have people report stuff.

My guess is that not only do these products tend to cost a lot of money, but I wouldn't be surprised if banks have internal risk scores that go in there and factor in how many credit builder loans and the $99 "debit" card. So is there any benefit or are people just being largely misled?

I can see how this all could end up as a costly backfire on the individual.

Let's say I'm the bank and Joe Blow comes in and says "I want a credit card." Am I going to give him one when he's obviously padded his credit file with obvious credit builder products that he pays for and which have no credit default risk to the "lenders"?

Well, I can say that if I was the bank, Joe Blow would have to beat it and try to get this stuff past someone else.

Meanwhile, Joe Blow with his credit report full of bankruptcy and credit builder loans just wasted about $350 and gets an eviction letter nailed to his door, and now he really can't find housing, while he was just in there asking me for a credit card.

By any metric of how debt-burdened and burdened by debt interest you use, Americans today have never been worse off as a group.

Incomes have stagnated, when you adjust for inflation. 

Yet you have all this easy "credit" out there where basically, you have a lamprey attached to you sucking out your money from your income so you don't have to say "Hey wait a minute. I make $80,000 a year and this SUV costs $80,000. Maybe I should get a Chevy Malibu and pay cash."

You have banks tossing people who are broke credit cards with $20,000 spending limits without once trying to figure out if they're employed or not or even have money in their bank accounts, unless they're under 21 and the law says you have to, or you have unusually good lending standards, like AmEx and they sometimes go "You know what, you're freaking us out, dude."

Credit card, mortgage, car debt. It's all through the roof. Student loans start back up, get ready for the toilet to flush.

There is more risk in the system than anyone wants to even think about. And a lot of that risk is the person who spends all this money that's not even theirs because the pain, I mean payments, doesn't kick in until the bill for their $80,000 war wagon starts coming in 30 days from now and doesn't stop until a tenth of a human lifetime later.

The guy in the CNBC video said to have good credit, don't miss any payments ever and don't abuse your credit cards to keep up with the Joneses, but that's like cigarette companies trying to convince consumers that there was a safer cigarette, or oil companies who knew about greenhouse gases in the early 1970s funding junk science. The fact is that most people out there feel societal pressure to show off even when it means letting their mouth write a check for the $80,000 war wagon that their income streams can't cash.

And that would be called a "car loan". Nobody really cares what you pull up to the stoplight in. Unless you need to impress business clients or something, it's just not important for most people to drive a new or expensive car.

In fact, I've been stubbornly fixing some aging vehicles because every month I don't have a car payment means another month and a half (compounding interest) closer I get to just buying a car and saving $7,000-10,000 that would go to the bank, and pay, I don't know....a year's rent with the interest money I didn't spend? And have a new car?

It'll be a reasonable one when I get there. When you worked for money and you see what kind of a check you'll write the dealership, it influences you. You don't go "Hey, here's two more months wages on an paint protection package (expensive wax) and a "GAP policy" (which they marked up 400% and you could buy from the car insurance company much cheaper anyway.

I'll get there on my own. Because I'll keep fighting, and I'll win. (Starship Troopers reference.)

Now, back to insurance for a minute. I usually don't file a car insurance claim because they have their own CLUE credit report, which is even worse than FICO or TransRisk or whatever they're using to say you have bad credit so here have a higher rate for no reason.

If you're in CLUE for anything bad, which could just be calling for a tow truck using your roadside, your rates go up. They count it against you as a claim for whatever they paid the tow company. And one time I had Metromile and they called a tow truck to a street in Chicago and I was in Indiana. So they reported to CLUE that they sent a tow truck and towed me when they didn't and try getting that off there, so I decided to just get AAA which doesn't tell anyone and never go down the route of asking the insurance for anything again.

So last time I was in an accident, I just didn't report it to anyone and bought a new bumper cover for the car and spray painted it myself and some new headlights, and hired a lawyer and fought off the red light ticket the cops were trying to blame me for so I checked my CLUE report and it's in there as a $0 Not at Fault claim because of course they get in and get city records so there's records of a police response to something but nothing about any damages, even though these two guys were trying to blame me for it they never appeared again, they certainly didn't come to my court date like they said they would, so I gave the cops and them my insurance, I just got lucky that they disappeared and never caused a problem and I was over in the driveway fixing my own car for a couple hundred bucks and you can't even tell anything happened except the headlamps are new so they look better.

When I realized that they weren't anywhere to be found and if I brought this to my own company they might or might not pay for anything, but they'd royally you-know-what me come renewal time, I just fixed it myself with parts from ebay.