Unfortunately you can't. This is one of my biggest gripes with the "free night" on your anniversary on your Chase Visa. Once upon a time you could almost stay at a good Marriot in the 1-4 category. Then, a couple hotels that were good, were moved into a Cat. 5. Now we are stuck with a below average-average hotel to use our free night. It wouldn't be so bad if you were allowed to bump your free night to a Cat. 5 for say 10,000 points. As it stands, at least in the Boston area, a free night at a Cat. 1-4 is almost not worth it.
I really wish they would re-consider the rules associated with this reward to allow some flexibility - it's very frustrating.
I just confirmed this with the CS. I don't see the issue with using my points or cash to upgrade. Very dissapointing! I switched from Hilton to Marriott several years ago when I got the credit card, but I'm considering going back to Hilton. While hilton points are watered down, they are much more felxible with their rewards and run a lot more specials. Will Marriott wisen up before they start driving members off?