Every once in a while, you receive small amounts of interest from your credit card company and you jump in excitement.
Well, that’s a good thing but, have you ever made an attempt to know how these card companies make money? If you do, you’ll realize that those bonus points you get are not charity offerings.
Credit card companies make big bulks of money from you and other merchants. As you read through you will discover various mind-blowing channels through which these card companies make money.
But, before we dive into that, you must first learn about their full business model. This will help you know how to use your cards wisely.
How Credit Card Companies Work
Credit card companies make a large portion of their profits from actual purchases and transactions. A 2018 Federal Reserve System report said that “although profitability for the large credit card banks has risen and fallen over the years, credit card earnings have almost always been higher than returns on all commercial bank activities.”
Credit card companies consist of two different enterprises: issuers and networks.
Issuers: These are banks and credit unions that issue credit cards, such as Chase, Citi, Synchrony, or PenFed Credit Union. When you use a credit card, you’re borrowing money from the issuer.
Networks: These are companies that process credit card transactions. They include Mastercard, Visa, American Express, and Discover are typically issued by a bank under contract with that retailer and are often referred to as “co-branded” credit cards.
Card issuers and networks make money in different ways. Networks typically make their money from the merchants, who pay a fee to accept electronic payments from credit cards.
The issuers make money from the consumer by charging them interest and fees according to their credit card agreements.
How Credit Card Companies Make Money
Here is a breakdown of how credit card companies make money from cardholders:
The majority of revenue for mass-market credit card issuers comes from interest payments, according to the Consumer Financial Protection Bureau.
When you carry a balance on a credit card, you’re typically charged interest in exchange for being able to borrow the money.
#2. Annual fees
Credit card issuers typically charge annual fees on rewards cards and on cards for bad credit. Depending on the card, annual fees can be pretty costly, especially for cards that offer top-tier rewards.
The Platinum Card from American Express, for example, charges an annual fee of $550.
#3. Miscellaneous charges
This category includes several potential fees. For starters, the card issuer will charge you a late fee if you don’t pay your bill on time.
They may also charge you cash advance fees, balance transfer fees, foreign transaction fees for purchases you make outside the U.S., or over-limit fees when you spend beyond your credit limit.
The fee amounts vary by issuer, but the good news is you may never have to pay these fees if you manage your card well.
#4. Cash advance fees
When you use your credit card to obtain cash, your credit card company charges you with a transaction fee called cash advanced fee.
They’ll also place your transaction into a different bucket on your statement, which typically has a much higher interest rate often over 20 percent.
Interest rates on cash advances tend to be higher than those for purchases and balance transfers. According to CreditCards.com, the average APR for cash advances is 24.8%, compared with an average of 19.84% for purchases.
#5. Balance transfer fees
When you transfer the existing debt to another lender, your credit card company charges you a balance transfer fee. The fee usually ranges from 3 to 5 percentage of the total amount transferred.
#6. Overlimit fees
An over-limit fee is charged when your balance goes over your credit limit. For instance, if your limit is $4,500 and you buy something for $5,000, you’ll be charged an over-limit fee.
Interchange is a transaction fee that the merchant’s bank account must pay whenever a customer makes a purchase with a credit card. This is usually a percentage of your total credit card purchase that goes to the credit card issuer and the association that manages the credit card account.
How to Avoid the Costs of Using a Credit Card
Credit card companies make a large part of their profits from cardholders but, that shouldn’t discourage you from using a credit card. The following ways can help you to limit the amount these companies make from you.
- Know what your annual fee is on all your credit cards: After this careful analysis, if you consider the annual fee worth it, then, read your card agreement and note all the potential benefits and take advantage of all the card has to offer.
- Avoid interest: Ensure you pay your bill in full each month. If there is a need to carry over a balance from month to month, do it on the card with the lowest interest rate, and pay it off as quickly as you can.
- Watch out for what you could be charged for and when: Choose a credit card without balance transfer fees.
- Setting up electronic alerts to can notify you when payments are due: This will help you avoid late fees.
- Set aside money in an emergency fund: This will help you to avoid costly options like cash advances.
Credit card companies make money from cardholders and merchants. To minimize the amount of money that credit card companies make off of you, use your cards wisely.