Can Credit Card Rewards Make Up for Bad Interest Payments?

Someone has probably told you before. “Don’t forget to pay your credit card balance, otherwise interest charges will be overwhelming.” However, this old adage may have become difficult to believe for some people who use rewards credit cards that come with rewards as high as 5-10% returns on purchases.

With such a generous offer from issuers, some people may wonder if interest charges even matter all that much. Perhaps, this may have even contributed to the increasing unpaid credit card debt that the Monetary Authority of Singapore has warned us about. However, our analysis below shows that paying off credit card debt in full every month is still very important. Although credit card rewards in Singapore are some of the highest in the world, interest charges will overwhelm them in almost every case.

For those who might be skeptical about such claims, it may be helpful to see the principle in action. Let’s assume we have a cash back or air miles credit card earning a 5% return on all our purchases. According to our study, most credit cards in Singapore carry an annualized interest rate of 25%. Also, let’s assume that we spend about S$2,000 on the card every month (average monthly expenditure for an adult Singaporean), and pay off 25% of our remaining balance every month. Over two years, we would end up paying S$2,765 in interest, and earn just $2,400 in rewards—a net loss.

While our model consumer would need to pay off about 28% of their monthly balance to break even, this kind of thought process could lead to a slippery slope. Given that interest rates on credit cards are so high around 25%, even going from paying off 28% of outstanding balance monthly basis to paying off 25% on a will lead to a loss of more than S$1,000 over a 24-month period.

Also, you should remember that arriving at the above results was moderately difficult, even with a simple set of assumptions of straight forward rewards rate and spending. Most credit cards you will encounter in Singapore have different rates for different categories of spending. Furthermore, your monthly spending could also vary month to month. In such cases, it will be rather difficult to micro-manage your balance and figure how much you have to pay each month to come out ahead.

APR's Hidden Costs

It is true that credit cards in Singapore are a lot more generous and lenient about this than their global counterparts. For instance, even Chase Sapphire Preferred® Card, one of the most popular rewards credit card in the US, offers only 2.5% while charging around 21% of interest rate, resulting in a much more scenario in terms of interest payments overwhelming value of rewards. Given this, some people in Singapore may look at our analysis and think “Great! I don’t have to pay for 70% of my purchases, and still not lose money!”

Such thought process, however, doesn’t consider the true danger of carrying a balance. For instance, what happens if you have an emergency expense come up? Life is never fully predictable. Perhaps someone close to you had a medical emergency, or perhaps your car started breaking down and needs a major maintenance service. Any number of possible scenarios could put a major strain on your - something you didn’t expect or prepare for. All of a sudden, your balance could grow to an extent that you are no longer able to pay off the necessarily 30%. If you can only start paying 20%, interest begins to eat away into your rewards. Overtime, it compounds and snowballs into a bigger debt that you may never be able to pay off. Depending on the severity of your emergency expense, this can ruin your credit score for good.

Bonuses Can Offset Interest Payments Only Temporarily

Credit card bonuses and promotions vary in value from hundreds of dollars to thousands. When you earn one, promotions and welcome gifts heavily skew the net returns in your favor for the first few months. However, over time, the impact of bonuses diminishes. After the first card member year is up, the initial boost in value typically diminishes and you begin losing money by carrying a balance. Not only that, monthly interest charged overtakes monthly reward earned quite quickly. In our example above, interest payments exceed rewards within 6 months, so you will be losing money every month from then on until you pay off enough debt on your card.

The hidden costs we described above are also just as dangerous, even if you earn a bonus. Don’t allow the short-term value boost to make you blind to the dangers of emergency expenses.

The most important lesson to take away from our analysis is this: make sure that you are able to pay off your charges fully at the end of the month before making purchases with your card. If your financial situation doesn’t allow for this, perhaps you should consider a card with low APRs instead of high reward rates.