Credit card companies make a ton of money. In 2020, a year that most businesses were worried about bankruptcy and defaulting on loans, credit card companies made an astounding $176 billion. Again, that’s a massive amount of money. This figure alone makes you wonder, just how do credit card companies make money?
If you’re curious about how these companies make the amount of money that they do, you’re not alone. Keep reading to learn about the way that credit companies make their money from customers like you.
How Credit Card Companies Work
When you’re talking about credit card companies, you’re actually referring to two different business entities in the same industry. These two different kinds of enterprises work together to make purchases using credit cards possible.
Credit Card Networks
When you receive a credit card, it’s going to have a label stamped on it. This label tells you whether or not you’re using a Visa, Mastercard, Discover, or American Express.
These four major labels refer to the major credit card networks in the country. Some of these networks also issue credit cards, meaning that they do business in both major forms of enterprise in the credit card industry.
Credit Card Issuers
The other major form of enterprise in the credit card industry is the credit card issuer. Credit card issuers are the entities that actually provide credit cards to consumers. These credit cards use the networks mentioned prior.
Issuers are banks and credit unions. When you sign up for a credit card, you’re borrowing money from these institutions. However, not all credit cards are directly issued by a bank or credit union. An example of this would be a retail branded credit card. These cards are issued by banks under a contract with the retailer and are sometimes called co-branded credit cards.
How These Companies Are Making Their Money
The money that credit card companies make originates from one of two places. It is coming from you, the cardholder, or the merchant, who is processing the credit card transactions. When you break down the ways that a credit card company makes money, it will fall into one of three categories, all of which are listed below.
Interest is the number one way that credit card issuers make their money. When a cardholder carries a credit card balance from month to month, the credit card issuer is authorized to charge interest. The interest is charged in exchange for the cardholder’s ability to borrow the money. They can only charge this when the card carries a balance, however.
When you’re reviewing the interest applied to your outstanding balance, you’ll find it expressed as the card’s APR, or annual percentage rate. This rate combines fees and interest into one expense, which can help you better understand the cost of the card. The cost is expressed as how much it will cost you in a year. The higher the APR, the more the card will cost you annually, so eliminating your balance is important to avoid high interest charges.
The other way that credit card issuers make their money is through their fees. There are a number of fees that most card issuers charge, some of which are standard and some are circumstantial. When it comes to making money, lenders that offer cards to people with lower credit scores rake in large amounts of cash from fees rather than interest.
While the larger, mass-market companies charge fees as well, subprime lenders have customers that are more prone to paying additional fees. Here are some of the common fees you’ll find in credit card contracts.
- Annual Fees: A once-a-year fee that card issuers charge cardholders for having one of their credit cards. Found on cards with high rewards or cards that require a low credit score.
- Late Fees: An additional fee added to the credit card balance when a cardholder fails to pay the minimum payment on time. Found on most credit cards. Some card issuers waive the first late fee, though it will still affect your credit score.
- Balance Transfer Fees: If you transfer your balance from one card to another, many card issuers will charge a percentage of the balance owed to do so. This charge is typically anywhere from 3% to 5%.
- Cash Advance Fees: The fee charged when a cardholder withdraws cash from an ATM using their credit card. The fees range from 2% to 5%. Most of the time, there is a minimum transaction fee, as well.
- Foreign Transaction Fees: These fees are charged when purchases are made outside of the country that the card is issued in. Many cards no longer carry these fees.
- Over-Limit Fees: A fee that’s tacked on when you spend beyond your credit limit. These tend to be fairly high fees.
Credit card companies charge merchants a processing fee for every credit card transaction. In this case, the credit card network makes money off of the businesses rather than the customer. The fee is called an interchange fee, and it is normally 1% to 3% of the total transaction cost. The fees aren’t made known to customers, typically. The amount of the fee varies based on volume, as well as the value of the transactions.
Avoiding Fees as a Customer
When you’re a cardholder, credit card companies are trying to make their money off of you, and they do this through interest and fees, as discussed previously. Thankfully, there are several different ways that you can avoid being charged unnecessary credit card fees. Check out some of these tips and tricks below.
Pay Your Balance in Full
The best way to avoid any fees or interest surrounding your credit card is by paying the card’s balance in full every month. Interest is the number one way that credit card issuers make their money. On average, the annual percentage rate on a card is anywhere from 15% to 30%. This can make things very expensive for you in the long run if you keep an open balance.
Stay on Top of Payment Due Dates
Every credit card issuer charges late fees. While some may waive the first or second late payment, they still impact your credit score, damaging it. If you want to avoid incurring any late fees, the best thing to do is set reminders. Most credit card issuers have a mobile app, so setting a reminder on your cell phone is often the best way to remind yourself that a payment is coming up.
Avoid Cash Advances
Being forced to use a cash advance from your credit card can be very costly, especially if you need a substantial amount of money. One of the simplest ways to avoid this is to set aside some cash for emergencies. Emergency funds can help you prevent paying more for an emergency than you have to.
Choosing the Right Card
Credit cards come with many alluring rewards and perks. However, these perks may not be worth it in the long run if other fees are high. For example, a cash back rewards card may be appealing. Some of these cards come with high annual fees, though.
Most experts recommend that you only choose a cash back reward card with an annual fee if the rewards will outweigh the cost of the fee itself. This can get a little tricky, depending on the card being reviewed.
Some only allow for a limited amount of cash back to be earned, meaning that they’ll never outweigh the annual fee. Be careful when choosing a card, and read through everything about it before agreeing to the terms and conditions.
Practice Good Spending Habits
Many people tend to forget that credit cards are tools to be used when necessary. Most professionals recommend that you only use a credit card for purchases that you’d already be making anyway. If you have bad spending habits, then a credit card can become a dangerous object in your possession.
The best way to avoid fees is by spending responsibly. Know your monthly spending budget and habits, and only use the card when the scenario calls for it. Credit card companies want you to spend as much as possible so that they can charge more. It’s how they make their money, after all.
Credit card companies make their money in a number of ways, and they make it off of their customers. Both cardholders and merchants are charged to use credit cards, be it the cards themselves or the credit card networks. Most of the money made is from interest on unpaid balances, as well as fees that are added to the use of credit cards. Combining that with processing fees, credit card companies are highly lucrative businesses.
However, the best way to avoid paying these fees and interest is by keeping your balance paid off. If you can’t do that, make sure your card carries a low-interest rate and that you make minimum payments on time.
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