Show me the money - cash is the best credit card reward of all

Credit card reward schemes are a mixed bunch - the best bet is usually a cashback plan, says David Prosser

lay the loyalty card reward scheme game well and you can disprove the theory that there is no such thing as a free lunch. The only problem is that rewards schemes are complicated - it can be difficult to work out which one is offering the most valuable perks and freebies.

There are two types of loyalty card in the UK. First, where your favourite supermarket or retailer offers a rewards scheme, signing up is a no-brainer - it costs you nothing to do so and any rewards you get back are a bonus. Whether to join the second type of rewards scheme - one of 80 or so offered by credit card lenders - is a tougher decision. If you end up paying more in uncompetitive credit charges than you get back in rewards, you'll lose out.

Richard Mason, a director of price comparison service Moneysupermarket.com, says the issue for credit card borrowers is whether they ever pay interest on their bills. "Those that do not repay their card in full each month will incur interest charges and they should try not to be drawn in by the free perks," he says.

"For these people, the main concern should be to find a card that allows them to pay as little interest as possible, such as a card with a 0 per cent introductory offer with no transfer fee, or a one with a fixed low standard rate."

In a way, comparing the cards on offer from different retailers is a pointless exercise. If you shop regularly in Boots, say, you may as well sign up for the chemist chain's rewards card, whether or not you think it is better value than the loyalty card scheme at B&Q, for example.

In contrast, once you've decided to pick a credit card on the basis of its loyalty scheme, comparing what's on offer is crucial. In the case of Nectar, the best-known scheme, there is an overlap with retailers' schemes - around 15 retailers issue points, as does one credit card lender. But that doesn't mean it's the best deal.

In fact, lenders see their loyalty schemes as a key front in the battle for customers. Barclaycard and American Express, two giant credit card lenders are currently trading blows over their schemes - last week, Barclaycard pulled out of the Nectar scheme, claiming that its customers were much keener on offers such as free travel insurance instead. Amex has replaced it at Nectar and insists it is offering a better deal than Barclaycard ever did.

For credit card customers, however, it can be tough to see the wood for the trees.

In most cases, borrowers in a rewards scheme earn points when they spend money, which are then redeemable against particular goods and services. The points you earn and what they will buy you vary from scheme to scheme - sometimes their value even varies within the same scheme depending on what you're buying - so the system is a long way from being transparent. For this reason, Martin Lewis, founder of Internet site moneysavingexpert.-com, says he prefers credit cards that offer cashback to those with loyalty schemes. "Cold, hard cash is the ultimate flexible points scheme," he says. "It can be spent on anything, anywhere so cashback cards that simply return a proportion of your spending as a cash lump sum each year are the benchmark."

Lewis says it is no coincidence that the best cashback cards, where borrowers can see exactly what they're getting, tend to be better value than more opaque loyalty schemes. "Any reward scheme that doesn't beat the best cashback cards is an automatic loser," he argues. "Just grab the cash and buy the reward with it and you will still be better off."

Currently, American Express's Blue card is the most generous cashback deal going. It pays up to 2 per cent back of your spending, though this is an introductory offer lasting three months - after which time the rate falls to 1 per cent on spending of more than £2,000 a year. Rival cashback lenders include Abbey, Bank of Ireland, Leeds & Holbeck Building Society and Morgan Stanley. All offer cashback of up to 1 per cent a year.

Morgan Stanley is one lender that has different cards offering cashback rewards. But Patrick Muir, the lender's director of marketing, says its cashback deal is more popular. "What customers seem to like is the absolute transparency, the very straightforward promise that if they spend a particular sum, they'll definitely get a set sum back," Muir says. "People don't always trust big corporations and I think there is sometimes a suspicion about rewards schemes."

However, in certain circumstances, loyalty schemes can work well. At Nectar, for example, customers spending on their American Express cards in participating retailers such as Sainsbury's, will double up the points they earn.

Brian Sinclair, director of client services at Loyalty Management, the company that runs Nectar, also argues that the scheme is so ubiquitous that its points are almost as easy to spend as cash. "We reckon 40 per cent of household spending in the UK is in outlets where Nectar points are redeemable," he says.

Alternatively, some cards offer a particularly good deal if you're looking for something very specific. The GM Card, for example, pays £3 for each £100 of spending, more generous than any cashback deal, but the money must be redeemed as a discount off a new GM car. "For Vauxhall lovers, this is a great scheme," says Lewis, "but everyone else should drive away."

Similarly, if you know you want to book your holiday through Thomas Cook this year, its credit card offers a generous £1.50 off the cost of travel for every £100 of spending on the plastic. And BAA's Worldpoints card is also good value, with up to £4.35 of rewards for each £100 of spending, as long as you're redeeming points against travel to Heathrow, Gatwick and Stansted.

In general, however, rewards schemes struggle to compete with cashback cards. The American Express Blue card would pay you £145 in the first year you use it, assuming a spend of £10,000. Moneysavingexpert.com's most recent analysis of rewards schemes, completed last autumn, shows few loyalty cards can match that.

The AA's Visa card, for instance, offers rewards worth £101 on the same basis. Cards from Toys R Us and Homebase offer £100. The best deal on air miles is £94, on BA's credit card, though you must fly with the airline. NatWest's air miles scheme is worth just £69.

At Nectar - to which 50 per cent of UK households are now signed up Moneysavingexpert.com calculates that each point you earn is typically worth 0.54p. Getting an American Express credit card to join the Nectar scheme is therefore only worthwhile if you're using the plastic in Nectar retailers. In this case, the doubling up perk means you get four points for each £1 - a reward of just more than 2 per cent.

A better bet might be to participate in Nectar through a retailer but to get Amex's Blue card instead. That way you'll have access to Nectar, plus the freedom to spend a generous rate of cashback where you want. If you don't pay your credit card bill in full each month, look for a cheap deal on interest charges.

'On this card I can spend where I want, when I want'

Suman Katyal, a 23-year-old public relations consultant from Kent, applied for a Morgan Stanley Cashback credit card two months ago.

The card pays her up to 2 per cent of her spending back in cash each year, though this is an introductory offer that lasts only until November.

"I chose this type of card because I knew I would be able to spend the cash where I wanted, when I wanted without restrictions," Suman says. "Compared to a card with a rewards scheme, this is dead simple because I just get a cheque each year - there is no claims form, or vouchers, for example".

However, Suman recognises the card is not suitable for everyone. "I have to be very disciplined about the way I use this plastic, because there is no point in getting cash back if I end up paying out more of this bonus money just in interest charges," she adds.

The rate on the Morgan Stanley card is 15.9 per cent a year - this means anyone who doesn't pay their bill in full each month is likely to be better off with a card offering an interest-free introductory offer.

Suman therefore intends to use the Morgan Stanley card, which is her second credit card, for everyday spending that might otherwise come out of her bank account. "This is spending I would do anyway so I might as well get paid for it, as long as I remember to pay the bill," she says.

Nectar points prove there's such a thing as a free lunch

Lina Milazzo lives with her husband Joe and their three children, Alessandro, who is seven, Luca, four, and Matteo, three, in Earlsfield, south-west London. The family initially joined the Nectar loyalty scheme through Sainsbury's, their local supermarket, and have become keen users of their cards.

"I collect points from many of the companies that participate in the scheme," says Lina. "It makes you want to go to places you know will give you points - we try to buy petrol at BP, for example, because we know it will earn us points."

Originally, Lina didn't pay a great deal of attention to how many points the family was racking up, but two Christmases ago, she discovered that they had enough on the card to pay for all their festive groceries - a £200 shop therfore cost the family nothing.

"That experience made me really want to collect points, so we used the card even more," she says. "Recently, we had reached 100,000 points and we were able to buy a widescreen TV without having to part with any cash at all."

Lina says the attractive thing about Nectar is that so many companies are members of the scheme. As a result, she says, there is a good choice of options for building up and redeeming reward points.

She also believes Nectar is a more transparent scheme. "We get statements each month, so we can see exactly what we have collected and what that's worth," she says.