The Worst Thing About Rewards Credit Cards (and How Banks Can Fix It)

I recently got an email from Bank of America (BAC) encouraging me to sign up for its BankAmericard Cash Rewards Card. It looked like a good offer: I could get a $100 bonus just for spending $500 in the first 90 days, and any rewards I redeemed into my Bank of America checking account would be boosted by an additional 10 percent. It also provides 2 percent cash-back on grocery purchases year-round, which would fit in nicely with my existing spending habits (and would encourage me to cook rather than dine out).

There's just one problem: The card's marquee cash-back category, with a 3 percent reward rate year-round, is gas. I live in New York City. And like many New Yorkers, I don't drive.

Pick almost any other category -- restaurants, movies, department stores -- and I'm in. But I'm not about to sign up for a card where the best cash-rewards category is useless to me. Still, it got me thinking: Wouldn't it be nice if you could customize your bonus categories, so that your rewards card is optimized for the sorts of things you actually buy?

After a bit of research, I've only been able to turn up one such card being offered today: The US Bank Cash+ card. Every quarter, you choose either gas, groceries or drug stores as a 2 percent bonus category. Then you can choose from several other categories to fill two 5 percent slots. If you tend to travel a lot, you can set hotels and car rentals as your quarterly 5 percent categories; if you go out to eat a lot, there are categories for restaurants and fast food joints. You can change the categories every quarter, so if you're planning to buy a computer or TV, for instance, you can swap in the electronics category.

As far as I can tell, this US Bank (USB) option is the only major card that offers this much flexibility in choosing your bonus categories. Odysseas Papadimitriou of CardHub.com says that such cards used to be more common, but card issuers found they weren't to their advantage.

%VIRTUAL-article-sponsoredlinks%"It can be a way to game the system," he says. "I get a card that gives me 3 percent back on gas and groceries, and my wife gets it on restaurants and discount stores... We can easily get 3 percent on six type of stores, and that might be 80 percent of our spending."

Even if you're not teaming up with a spouse to cover all your spending across two cards, such a system still makes it easy for an individual consumer to target his or her biggest-spending categories year-round. And while that's great for the cardholder, it's not so great for the bank.

That's because such a scheme is at odds with the business model of rewards cards. Banks can give out those tempting cash-back rewards because they're getting "rewards" on every purchase too -- in the form of swipe fees, which typically fall in the 2 percent to 3 percent range. So when you spend in one of those 5 percent bonus categories,they aren't turning an immediate profit -- but they make up for it on the rest of your purchases, which only earn you 1 percent cash-back. (And of course, it pays off for them regardless, if you carry a balance.)

On a typical card with rotating bonus categories, the 1 percent back purchases will tend to outnumber the 5 percent ones. This quarter on my Chase Freedom card, for instance, I'm planning to take advantage of 5 percent cash-back on Amazon and select department stores -- but last quarter, it was gas stations, theme parks and Kohl's (KSS), none of which were useful to me. Rotating categories in this way prevents the cardholder from spending too much on 5-percent-back purchases, and thus keeps things profitable for the bank. But if I were allowed to choose my categories, I would obviously optimize things to my own spending habits, and that means less money for the bank.

So it's not hard to see why most banks aren't willing to offer a card with the flexibility of a Cash+ card. Still, offering users some degree of customization when they sign up for a card seems like it could be a good move for banks looking to win customers in a competitive climate. I can't imagine I'm the only one who's turned down an otherwise attractive credit card offer because I found some of the categories would be wasted on me. Why not offer a card with certain fixed rewards categories, but with a "wild-card" slot for a bonus category of the cardholder's choice?

I know I'd have a couple more credit cards in my wallet if banks were willing to be that flexible.

Matt Brownell is the consumer and retail reporter for DailyFinance. You can reach him at Matt.Brownell@teamaol.com, and follow him on Twitter at @Brownellorama.