What cash back actually is

Cash back is a percentage of the money you spend that the credit card company returns to you. When you use the card to buy something, the merchant pays the card issuer a fee (usually 2 to 3 percent of the purchase). The card issuer then gives you back a portion of that fee as a reward. You don't pay anything extra — the price you see is the price you pay.

The amount returned varies by card and by category. Some cards give 1 percent back on everything. Others give 3 percent on groceries, 2 percent on gas, and 1 percent on everything else. A few cards offer 5 percent on rotating categories that change each quarter. The card issuer decides these rates and can change them, though they usually give cardholders notice before doing so.

Key Takeaways

  • Cash back is a rebate on purchases, paid by the card issuer from the merchant fee, and appears as a credit to your account or a check.
  • The percentage you earn depends on the card and the category — groceries, gas, and dining often have higher rates than general purchases.
  • You only earn cash back on purchases you actually make; you do not earn it on cash advances, balance transfers, or fees.
  • Cash back has no value if you carry a balance, because credit card interest charges will exceed any reward you receive.
  • Different cards have different redemption methods: some deposit cash back automatically, others require you to request it, and some have minimum thresholds before you can redeem.

How the money reaches you

Cash back reaches your account in different ways depending on the card. Some cards deposit it automatically into your checking account once a year or once a quarter. Others hold it in a rewards account within your credit card account and let you request a check or a statement credit whenever you want. A few cards require you to reach a minimum amount — often $25 or $50 — before you can redeem anything.

Statement credit is the most common method. When you request it, the card issuer subtracts the cash back amount from your next bill. This is instant and costs nothing. If you want the money in your bank account instead, some cards offer that option but may take five to ten business days to process. A small number of cards mail a physical check, which takes longer but gives you the cash in hand.

Check your card's terms to see which methods are available and whether there are any restrictions. Some cards let you choose your redemption method; others lock you into one. If your card requires a minimum threshold and you don't spend enough to reach it, the cash back simply sits in your account until you do — it does not expire, but you cannot access it until the threshold is met.

Which purchases earn cash back and which don't

Cash back applies only to purchases you make with the card at merchants who accept it. It does not apply to cash advances (withdrawing money from an ATM using your credit card), balance transfers (moving debt from one card to another), or fees charged by the card issuer itself, such as annual fees or late fees. Some cards also exclude certain categories: gas station purchases at the pump sometimes earn a lower rate than in-store purchases, and some cards don't reward purchases at casinos or gambling establishments.

The category that earns the highest rate varies by card. Common high-earning categories include groceries (often 3 to 5 percent), gas (2 to 3 percent), dining and restaurants (2 to 3 percent), and travel (1 to 5 percent depending on how you book). Everything else usually earns a flat 1 percent. Some cards have rotating categories that change each quarter — for example, 5 percent on groceries in January through March, then 5 percent on gas in April through June. You have to activate these categories each quarter, or you'll earn only the base rate.

Merchants are classified by a code that determines which category a purchase falls into. A grocery store purchase codes as groceries. A gas station codes as gas. But a convenience store that sells gas and snacks might code as convenience, which could earn a lower rate. If you're unsure whether a purchase will earn the rate you expect, contact the card issuer before you buy, or check your statement after to see what rate was applied.

Why cash back doesn't help if you carry a balance

Cash back only saves you money if you pay off your balance in full each month. If you carry a balance, the interest you pay will almost always exceed the cash back you earn. For example, if you earn 2 percent cash back but pay 18 percent annual interest on a balance, you're losing money overall. The math is simple: the interest charge is nine times larger than the reward.

This is the most common mistake people make with cash back cards. They see the reward rate and think they're getting a deal, but they're actually paying far more in interest than they receive back. If you cannot pay your full balance each month, a card with cash back offers no real benefit. A card with a lower interest rate, or no annual fee, would serve you better.

Comparing cash back rates across different cards

Cash back rates vary widely, and the "best" card depends on how you spend. A card that gives 5 percent back on groceries is only valuable if you buy groceries regularly. If you rarely cook at home, that rate does nothing for you. The same applies to gas, dining, and travel categories.

To compare cards, list your top spending categories and how much you spend in each per month. Then look at what rate each card offers in those categories. Multiply the rate by your monthly spending to see how much cash back you'd earn per month. Do this for two or three cards and pick the one that earns the most in your actual spending pattern. Ignore cards that offer high rates in categories where you don't spend.

Also check for annual fees. A card that charges $95 per year needs to earn at least that much in cash back to break even. If you spend $5,000 per year and earn 2 percent cash back, you'll earn $100 — enough to cover a $95 fee. But if you spend less, or earn a lower rate, the fee eats into your reward. Many cards with no annual fee offer 1 to 1.5 percent cash back on all purchases, which is simpler and costs nothing.

How card issuers make money from cash back programs

Card issuers can afford to pay cash back because merchants pay them a fee on every transaction. That fee is typically 2 to 3 percent of the purchase amount. The issuer keeps most of it and returns a small portion to you as cash back. They also make money from interest charges on balances that cardholders carry, and from annual fees on premium cards.

The issuer's goal is to get you to use the card more often and to carry a balance. If you pay in full each month, the issuer makes only the merchant fee. If you carry a balance, they make much more from interest. This is why cards with high cash back rates often have high interest rates too — the issuer is betting that you'll eventually carry a balance and pay far more in interest than you earn in rewards.

Frequently Asked Questions

Does cash back count as income for taxes?

No. The IRS treats cash back as a rebate on your purchase, not as income. You don't report it on your tax return. This is different from a sign-up bonus, which may be taxable in some cases depending on the amount and how the issuer reports it.

Can I lose cash back I've already earned?

Cash back you've earned and posted to your account cannot be taken away. However, if you close the card before redeeming your cash back, some issuers will let you keep it and others will not. Check your card's terms. If you plan to close the card, redeem your cash back first.

What happens to cash back if I return something I bought?

When you return an item, the merchant refunds the purchase and the card issuer reverses the cash back you earned on that transaction. The cash back disappears from your account. If you had already redeemed it as a statement credit, the credit is reversed and added back to your balance.

Do I earn cash back on credit card payments?

No. Paying your credit card bill is not a purchase — it's a payment. Card issuers do not allow you to earn rewards on payments, and most merchants won't let you pay a credit card bill with another credit card anyway.

Is there a limit to how much cash back I can earn?

Most cards have no annual limit on cash back. You can earn as much as your spending allows. However, some premium cards cap cash back at a certain amount per year, or they limit the amount you can earn in a specific category. Check your card's terms to see if any limits apply.