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Are Cash-Back Rewards Good Deals for Consumers?

By Zac Bissonnette

PerkStreet Financial, the Boston-based company behind the high-rewards debit card that was a favorite among personal finance obsessives, announced on Monday that it’s ceasing operations as of Sept. 26. Customers with un-redeemed cash-back rewards will not be receiving them. As the New York Times’ Ron Lieber had sort of predicted in a 2010 column when the company was first making waves, PerkStreet’s high-rewards model turned out to be unsustainable. When no acquirer surfaced, it couldn’t make good on its promises.

Customers who’ve lost their rewards are of course letting the company have it on Twitter, and Dave Ramsey, who was a paid endorser of PerkStreet until the end of last month, ripped into it in a rant on Monday.

“We found out the same way you did because they’re slimy,” Ramsey said. “The guys that run that thing have had dinner in my home multiple times. I’ll find them eventually and strangle them. . . I’m about six million times more pissed than you are because that’s how embarrassed we are.” And with that, a riff from Michael Jackson’s “Smooth Criminal” led the show into a commercial break.

But putting aside the outrage and disappointment, though, was PerkStreet’s 2% cash-back deal really that great for consumers?

A 2010 Federal Reserve Bank of Chicago study found that credit card users who were given a chance to earn 1% cash back rewards received $25 a month in rewards—but increased spending by $68 a month in pursuit of those rewards. Some of that jump was attributable to shifting of spending from other accounts, but not all of it. As The Wall Street Journal noted: “That means that, for a lot of people, the benefit of a cash-back reward is negated by increased overall spending and debt.”

Without PerkStreet in the picture, there are few options for rewards-seeking debit card users—which brings us back to credit cards as the popular option if the stuff you’re buying isn’t enough of a reward for the money you’re spending.

There, the behavioral factors that plague rewards are compounded by the problems that come with using credit cards. The title of a 2001 paper from MIT researchers published in Marketing Letters tells the story: "Always Leave Home Without It: A Further Investigation of the Credit-Card Effect on Willingness to Pay." In the study, researchers found that students who were asked how much they would pay for certain items responded with far higher amounts when told they could use a credit card: “All three premia, and the premium for the Celtics tickets in particular, were more substantial than could be justified by the financial benefits of credit cards,” they wrote. In the case of Celtics tickets, the "credit card premium" was 113%.

Other research has shown that credit card users are more likely to leave larger tips in restaurants and to forget how much they’ve spent. Research published in 2008 the Journal of Experimental Psychology: Applied found that credit cards and other non-cash payment methods like gift certificates led to increased spending. Virtually every study that has ever looked at the impact of credit cards on purchasing decisions shows a rise in spending that more than offsets the most generous rewards programs.

The lesson is clear: If you want to curb spending and get ahead financially, use cash when you can, debit cards when you have to, and credit cards almost never.

But how satisfying would that be? So much of the allure of rewards cards is the chance to feel smart—to feel like you’re beating the credit card issuers at their own game as you get free stuff without ever paying any interest because you, of course, never carry a balance.

However, the impact of credit card use on spending still hits your bottom line, even if you do pay the bill in full each month.

That advice runs counter to the life-hacking culture that's infiltrated personal finance—where coming up with clever ways to optimize things is far more important than all that boring talk about thrift and temperance Ben Franklin and Sylvia Porter lectured us about. But your best shot at winning the credit card rewards game is probably to just skip it entirely.

Readers: Do you use a cash-back rewards credit card? Do you think it makes you spend more than you would have otherwise? Tell us in the comment section below.