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How credit card rewards can bail you out of debt

New credit card programs reflect consumers' changing attitudes

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It used to be that the reward for paying your bills on time was a good credit score, but with rising credit card defaults threatening financially shaky banks, some card lenders are trying a different approach. They want to encourage customers to save more money, invest wisely and budget family expenses. Card issuers offer rewards to build savings, pay off debt

"Our customers have been telling us, 'We need help with getting a plan to pay our debt down more quickly,'" says Ben Soccorsy, a product manager for San Francisco-based Wells Fargo. "We're trying to be as responsive as we can to our customers, especially during this difficult environment."

To accomplish that goal, Wells Fargo unveiled its Debt Pay Down Solution in December 2008, a consolidation loan that is linked to an online spending report so customers can more easily see where they have money left over to apply to their debt. The company also unveiled its Wells Fargo Cash Back Card, which offers 1 percent cash back on all purchases that can either be applied to the debt or can be deposited into a checking or savings account. 

"We're trying to help our customers meet all of their financial services needs," says Soccorsy. "When they are successful in achieving the goals they set out for themselves, I think we build deeper relationships with them." 

Rewards inspire loyalty
Whether increased savings and smaller debt loads will ultimately make customers more loyal to their credit card issuers remains to be seen, but rewards cards in general have proven to be popular with consumers. According to a January 2008 survey by the Boston-based research and advisory firm Aite Group, consumers rank card rewards as the second most important feature that led them to choose one card over another. The only factor deemed more important was whether the card charged an annual fee.
Charging toward retirement

Seventy-eight percent of working Americans worry they aren't saving as much for retirement as they should, according to a September 2008 study by Boston-based Fidelity Investments. Now, credit card issuers are hoping to capitalize on that fear by offering products to help credit card users save for tomorrow as they spend today.

"Our customers are concerned about the market environment and have concerns about where their money is going," says Josh Krugman, manager of the credit card business at Fidelity. While the company's Retirement Rewards Card shouldn't be the focal point of a customer's retirement strategy, it can boost retirement savings efforts of cardholders who use the card regularly and pay the balance off each month.

Cardholders get 2 percent back, which is automatically deposited into a Fidelity IRA. While there are no limits to rewards, cardholders must spend $2,500 before they can redeem their points, so every time a cardholder spends $2,500, $50 is automatically deposited into the account.

Stopping short of offering a rewards program geared specifically toward retirement, Charles Schwab Bank, based in Reno, Nev., also encourages customers to save for their futures by giving them the option to have 2 percent of cash-back rewards deposited directly into a brokerage account. Customers can do with the money whatever they want, but "we hope that clients will put it into a savings product or money market or some other longer-term investment," says Richard Musci, chief marketing officer for Charles Schwab Bank. "It's a pretty sound strategy to fund your IRA."

If you're thinking of signing up, here are some things to consider:

Get out of debt first. "If there's a customer who's looking for a low-rate APR card to revolve a balance, I wouldn't recommend a Fidelity Retirement Rewards card," says Krugman. The retirement gains would be offset by the interest the customer pays each month.

Compare retirement products. Since retirement and investment rewards cards go hand-in-hand with specified investment accounts, make sure you're comfortable with the investment vehicle before signing up for the credit card.

Consider retirement savings limits. Since there are limits to how much consumers can deposit in retirement accounts each year, review your contributions to make sure rewards points don't push you over the top. Both cards give you the flexibility of depositing earned rewards in a subsequent year if cardholders have maxed out their retirement accounts. 

But while rewards programs in the past have provided cardholders with free airline tickets, hotel discounts and retail savings, programs are increasingly offering credit cardholders incentives to save and use credit more responsibly.

Discover Financial Services, for example, introduced its Motiva Card last year to reward customers for paying down their debt. The card is designed for cardholders who carry a balance. When they make on-time payments six times in a row, they are rewarded with cash back in the equivalent of the next month's interest.

To help its customers manage their debt even further, the Riverwoods, Ill.-based Discover introduced two online planners earlier this year -- the Paydown Planner and the Purchase Planner. Both are personalized, meaning cardholders' account information is automatically plugged into the tool. In the case of the Paydown Planner, the cardholder can then determine how much he or she should be paying each month to get the debt paid off by a certain time. The Purchase Planner lets cardholders determine how a purchase would affect their minimum payment and the time it would take to pay off the entire balance.

The shift toward financially responsible rewards programs has come about partly because cardholders have asked for it, says Richard Musci, chief marketing officer for the Reno, Nev.-based Charles Schwab Bank. The company this month introduced its Invest First credit card, which offers 2 percent cash back on purchases and automatically deposits the money into a Schwab One brokerage account each month.

The company discovered through customer surveys and rewards programs in the past that customers preferred to receive cash back rather than discounts on products and services.  "Seventy to 75 percent of people were saying they'd rather have the cash at hand instead of using the redemption values on anything else," says Musci.

Once the money is deposited in the brokerage account, it can be used any way the customer wants. "They may want to use it to pay down their mortgage, they may use it to fund a college plan for their children, or they may want to use it to pay off debt," says Musci. "That's a strong value proposition for customers depending on what they want to do with that money."

Allowing cardholders to determine how they'd like to use cash back rewards seems to be trending up. The Citi Forward card -- which is being marketed as "the card that rewards you for good behavior" -- is offering cardholders the opportunity to redeem ThankYou points for student loan rebates, charitable donations and statement credits. Plus, if cardholders make a purchase, stay under their credit line and pay on time for three billing periods in a row, Citi says it will reduce the annual interest rate on the card as well as award 100 points each billing period.  

The Citi Forward card emerged out of two years of customer research indicating card users wanted different rewards and incentives, says Terry O'Neil, executive vice president at Citi Cards.

"People would rather be rewarded for the right things that they do rather than being penalized for the mistakes that they make," O'Neil says. "They were interested in a credit card that rewarded them for good financial behavior."

The card features a variable interest rate of prime plus 9.99 percent. Users who pay their bills on time and don't exceed their credit limits can see a 0.25 percent decrease in the APR each quarter -- up to 2 percent over the course of the year. Other features of the card include e-mail or cell phone alerts that warn users when they are close to their credit limits and tools that allow them to track their spending or compare their spending levels to others in their peer group. Adds O'Neil: "It's designed to get people to use credit wisely."

And the Upromise rewards card program -- which was managed by Citi, but has been taken over by Bank of America and is owned by student lender Sallie Mae -- is designed to help parents fund 529 college savings programs through rewards redemption. Cardholders earn cash rebates by shopping with designated merchants and apply those rebates every quarter to aUpromise-managed 529 account -- or the savings can be applied to pay down Sallie Mae-serviced student loans.

A winning proposition
While these products are designed to help consumers better manage their finances, they also help card issuers reduce their own exposure to the risk of credit card defaults by debt-strapped borrowers. In late 2008, card issuers have been closing dormant card accounts, reducing customer credit lines and cutting back on direct mailings to acquire new customers, all in an effort to concentrate on customers who are less likely to get into financial difficulties that prevent them from paying debts.

"Card issuers like the person who carries a $5,000 balance, runs it up once a year and pays it back -- that's the bread and butter of the credit card world," says Ken Clark, a certified financial planner and author of "The Complete Idiot's Guide to Getting Out of Debt." "Not someone who's $25,000 in debt."

Card issuers also benefit from introducing customers to new products. For example, since unveiling the Invest First credit card, Schwab has already seen new customers open brokerage accounts to take advantage of the investment rewards, Musci says.

"No credit card company is in the business out of the goodness of their heart," says Clark. "They're all in it to make a profit and it's a very competitive market. To some degree all of these things are marketing gimmicks."

For consumers, the rewards programs and financial tools can help them pay down debt and save money as long as they use the credit cards wisely. "They are not the solution to your debt problem, but they can make debt use smarter," says Clark.

If you currently have a balance:

  • When selecting a credit card, pay more attention to the interest rate offered than to financial rewards since the interest you'll pay is likely to outweigh any money saved via rewards.
  • Look for a rewards card such as the Motiva that's geared toward cardholders who carry a balance, since the higher your debt load, the higher the rewards.
  • Once you settle on a card, use complementary online financial tools such as Wells Fargo's online spending report and Discover's Paydown Planner to spot ways to cut back on spending and pay debt down sooner.
If you don't have a balance:
  • Consider whether there's an annual fee since that affects the ultimate value of the rewards. 
  • Look for a card with rewards aligned with your savings goals.
  • Use complementary online financial tools to determine ways to increase savings.

"Some people think credit cards are bad," says Musci. "Well-managed credit cards are great because you're going to be buying goods anyway.  Put them on a credit card, get the 30-day float, pay it off in full every month and save 2 percent."

See related: Use it or lose it: Issuers quick to close dormant accounts, Banks focus mailings on current customers, not new ones

Updated: April 6, 2009


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