Effective Cash Back Rate: What It Is and How to Determine It

Editorial Note:

How to Calculate Cash Back Rate with 3 Examples (Updated: 07/15/2020)

It’s important to assess how “good” a credit card is by calculating the effective cash back rate. This is how much value the card gives back for the money spent using it. The effective cash back rate is not the only factor to judge a rewards credit card’s worth. Yet, it is a quantitative measure by which to judge the best option for a credit card.

How to Calculate the Effective Cash Back Rate

There are a couple of steps to determining the effective cash back rate.

  1. You need to find out the value of the credit card’s rewards before the annual fee is applied. Estimate how many points you can earn and translate this into monetary terms.
  2. Calculate the dollar value of any bonus offers.
  3. The value of the rewards, points and bonus offers should be added together.
  4. From this total, subtract the annual fee. What remains is the net value of the card, in terms of cash.
  5. To calculate the effective cash back rate, divide the net value by the amount you need to spend.

Let’s use an example to illustrate our point. You want to take a trip from Chicago to New York City. If you use your credit card, it will cost you 20,000 airline miles. Typically, the flight is $400. The value of each mile is then

$400/20,000 miles = $0.02 per mile.

The card you’re using lets you redeem 1 mile for each dollar that you spend. To earn the 20,000 miles you need, you would have to spend $20,000. Without taking annual fees, or bonuses into account, the face value of your effective cash back would be


Now, the card may offer a sign-on bonus of 15,000 miles, and an annual fee worth $100. Subtracting the bonus miles from the original amount, you now need to earn only 5,000 miles. This changes your cash back rate to


The annual fee reduces the value of the ticket by $100 from $400 to $300.  Your effective cash back rate is now


The example we used is simplified and did not take into consideration various factors that may occur in real life. Your spending pattern may be different. The card you choose may have a higher flat rate or offer multi-tier rewards. Many retail cards offer different earning rates at merchants like grocery stores or gas stations. Your cashback rate will change depending on where you shop.

How to calculate cash back?

Three Scenarios for a Better Understanding

Scenario 1. One of Your Largest Spending Categories is Groceries

You may find that a big chunk of your paycheck goes to the supermarket. It will be beneficial to get a credit card with the highest cash back rate at grocery stores.

The Blue Cash Preferred Card from American Express credit card is a great example.

  • You’ll earn 6% cash back on the first $6,000 spent at U.S. supermarkets (and 1% on each dollar thereafter) and select U.S. streaming subscriptions.
  • Transit and gasoline purchases at non-store brand gas stations earn 3% cash back. (Buying gasoline at Kroger or Costco does not qualify for the 3% cash back rate.)

You should review the card’s terms and conditions, or contact American Express‘s customer service for more information. These cash back rates make the card look very attractive, but don’t ignore the $95 annual fee. To get the maximum cash back, you will need to spend $6,000 on grocery purchases annually.

Let’s consider another card: the Bank of America Cash Rewards card has a different tier scheme. It earns:

  • 3% for the category you choose: gas, online purchases, restaurants, travel, pharmacies, or home improvement & furnishings. You can select a different category each month.
  • 2% on groceries and at wholesale clubs;
  • 1% everywhere else;
  • 3% and 2% cash back in combined choice category/ grocery store/ wholesale club purchases (available for the first $2,500 spend each quarter), then 1%.

This card does not have an annual fee. To maximize cash back, it’s best to use this card for every purchase.

Scenario 2. You Travel a Lot and Have a Preferred Airline

You’re always planning and purchasing your next trip, and you have loyalty to a particular airline brand. Perhaps they have the best customer service, or your local airport is their regional hub. Whenever you fly, you’re likely to use this particular airline. You’ll get the most cash back from a card designed to earn miles or points redeemable with your airline of choice.

In this scenario, the trick to getting the maximum out of your cash back rate is timing. Knowing when to cash in your points or miles is crucial. Redeeming your miles during a low fare season (the wrong time) will reduce your effective cash back rate. Using your miles during the high fare season is a better choice.

Case in point: let’s say $1 spent earns you 1 mile. You have 100,000 miles sitting in your rewards account. The ticket you want is on sale and can cost either $800 or 100,000 miles during the low fare season. If you use your miles, you would have an effective cash back rate of


Unfortunately, you took too long to make up your mind and miss the sale fare. The same ticket is now $2,000 or 100,000 miles. This time, you don’t hesitate (as your departure date is approaching), and you buy the flight with your miles. Now, the effective cash back rate becomes


Based on the two calculations, your hesitation was not unfortunate after all. By purchasing your ticket at the higher price, your effective cash back rate was greater. It was more than twice what it would have been had you purchased the ticket on sale. (This was assuming the number of miles for redemption remained the same.)

Scenario 3. You’re a Savvy Shopper

You are always on the hunt for a great deal at your preferred stores. (How else can you balance shopping for needs and wants with sticking to a budget?) To capitalize on your shopping habits, use a store credit card and rewards point program affiliated with your preferred merchant(s).

The points you earn can be redeemable for various rewards. You may trade points for in-store purchases. Buying gift cards with your points is a brilliant and valuable decision. Many stores may offer the gift cards at a 10 or 20% discount off the purchase price. Points can usually be used on bonus days in store and online. Rewards members can earn more points per dollar or score even more significant discounts, in addition to using earned points.

Here’s a case of how your credit card cash back can add up when used wisely.

This example was based on something that happened in real life. A nearby store that you frequent has the following promotion available. If you spent $40 or more with their store credit card, you would receive an additional 10,000 bonus points.

Save Money Buying Christmas Presents

The bonus points would be added to the regular points you would typically receive with the $40 purchase. At this store, 10,000 points is equivalent to $10. To receive $10 back on a $40 purchase, your cash back rate is


You were planning to purchase a number of items, totaling about 350 dollars. If you had paid for the items in one transaction, you would have only earned $10 cash back. Your cash back rate would have been


Instead, you asked the cashier to break up your purchase into 6 transactions, for which you earned $10 each time. Your actual cash back rate is


By making six purchases instead of one, you increased your cash back rate by more than 14%. You did not buy anything extra or spend any more money. Had you attempted to maximize the transaction, you would have realized that $350 divided by $40 equals 8. In other words, you could have made eight purchases to earn the most cash back. (Another alternative would have been to add a $10 purchase and bring your total to $360. Then you would need 9 transactions to earn the most cash back.)

Assuming that you did not want to purchase additional items, your cash back rate with eight transactions would be


Just like that, you earned extra cash back of $70 and increased your cash back rate by 20%.

Your primary credit card may not be as generous with their rewards program. This makes a store credit card that is tied to a rewards program an excellent choice for a secondary card. Store credit card cash back varies between retailers. They are also supercharged when used in conjunction with the store rewards program. In fact, stores sometimes offer exclusive opportunities to store credit cardholders. On occasion, customers with store credit cards could earn double points when paying with their card.

You should note that some stores cards do not have an annual fee. Not having an annual fee is desirable, and makes the card definitely worth having. If a card has an annual fee, you must take this into account when calculating the effective cash back rate.

Final Thoughts

The most important reason to calculate your effective cash back is to understand how much you’ll actually earn. A credit card’s advertised cash back rate may not match the actual cash back rate when other factors are applied. This includes annual fees or additional bonuses you can receive through using the credit card. Your spending habits determine whether you’re using the card efficiently enough to take full advantage of the cash back. How you repay your credit card should also be considered when attempting to figure out the effective cash back. Your cash back calculations are only accurate if you pay off your balance every month, in full. Interest, late fees, and other penalties act like the annual fee, decreasing the value of the rewards, points, and bonuses. Missing even one payment will distort the accuracy of the calculations.

Roman Zelvenschi

I started a digital marketing agency Romanz Media Group Inc. 12 years ago. Running my own business quickly taught me the importance of cash flow. Making sales was not enough, I had to have money in the bank to pay the vendors, staff and personal bills.

During those early stages of the company I learned how to get creative with debt and to save on interest cost. I paid for everything I could with a credit card to both get more points and to extend the payment date by 25 days (credit card grace period). I then utilized a 0% balance transfer offers to rotate this debt.

I learned a lot during this process and made a lot of mistakes. My key lesson is that the most important part of being financially independent is how much I managed to save, rather than how much I earned. Staying disciplined with savings and tracking spending is not easy and I tried many different methods to stay on track.

FinancialFreedom.Guru is a side project where I and my staff are trying to share the practical knowledge on how to understand finances and to build wealth.

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Matt Barnett
Matt Barnett
6 months ago

How to calculate cash back percentage?

Ekaterina Redko
6 months ago
Reply to  Matt Barnett

Follow these steps:
1. Find out the value of your credit card’s rewards
2. Determine how many points/miles or how much cash back you earn with your card
4. Calculate the dollar value of bonus offers, if there are any
5. Add these three values together
6. Subtract the annual fee
7. Divide the number you get by the amount you need to spend.
For a better understanding, study the real-life examples in the article.

Ted K
Ted K
4 months ago

You can also use cash back on things like car insurance, breakdown cover, mobile phone deals and holidays. I used to forget about it but this year I have had $55 Cashback on my car insurance alone

2 months ago

 If you’re in Canada, I recommend PC financial card🙂 they have plenty of use. You can earn points from Esso, Mobil, Shoppers, no frills, and Superstore. You can earn points from your essentials and save points to redeem for the same.
Or you can also get those rewards+ points earning credit card that converts your points to investment dollars to buy stocks. (RBC visa).

2 months ago

I always read the fine print, or even call the credit card company and ask them for the details to make the right choise of a credit card

2 months ago

I love a discount and rewards and I use some. I don’t like having to trade my privacy for them though. I guess I could use a burner phone and create a fictitious identity. Anyone figure out a way to leverage these type of rewards, but not give out personal information or let marketers track your habits and patterns?

2 months ago

I love Capital One Bank. It was my first credit card when I was 18. It was so easy. Never had any issues with it.

2 months ago

The best ones for starter cards are Capital One and Discover. They have no annual or monthly fees

Robin H
Robin H
2 months ago

I have Capital One. Love the cash back. I use it to pay on my balance. Had it for 2 years. Love it.