I know you've also probably asked yourself this question at one time. How do credit card companies make money? Well, here is everything you need to know about credit cards.
It's a well-known fact that most credit card companies make a considerable chunk of money, majorly from interest, fees charged to cardholders, and, lastly, via the transaction fees that are being paid by those businesses that accept credit cards.
In this article, you will learn how credit card companies make money. Also, we will explore the ways you can try to minimize the amount of money that most credit card companies try to gain from you.
Before we delve deeper, let's understand how credit card companies work.
Table of Contents
How Do Credit Card Companies Function?
Mainly, all credit card transactions include two kinds of enterprises: issuers and networks. Here's what they mean;
Issuers
They are primarily banks and credit card franchises that make credit cards like Chase, Citi, Synchrony, or PenFred Credit Union. So, basically, you borrow money from the issuer each time you use a credit card.
For example, those retail credit card companies that come with the name of a store, gas company, or any other merchant are issued mainly by a bank that is under a contract with the retailer. Another name for issuers is “co-branded” credit cards.
Networks
These organizations help in processing all kinds of credit card transactions. The major players in this area in the United States are Visa, Mastercard, American Express, and Discover.
Money travels electronically and via many hands, from the credit card issuer to the networks and finally to the merchant's bank each time one uses a credit card. In this process, the network's responsibility is to make sure that all the transactions are finally attributed to the credit card holder, allowing the issuer to bill him.
So, How Do Credit Card Companies Make Money?
Wondering where the money comes from? Now, let's dive in!
Credit card companies are hugely profitable. Consumers usually make a lot of their share, acting as merchants every time they use their cards.
Listed below are some ways which clearly show where these cards get their money:
Interest
According to data from the Consumer Financial Protection Bureau, interest payments make up a larger chunk of revenue for credit card issuers. But you can avoid any kind of interest if you want. This is because you are typically charged interest or any cash advance fees, and even balance transfer fees when you have a balance every month.
So, if you act smart and pay your balance in the total amount, you will not have to pay any interest fees.
Fees
Then there is the existence of subprime users specializing in people with bad credit. This lets them earn more money from the fees alone, much more than interest fees.
On the other hand, these mass-market users also charge many fees, and we list the different kinds of fees below. Please note that these can be avoided too.
See related: How Long Does It Take to Build Credit?
Annual fees
These are fees that are pretty typical on cards that usually have high reward rates and apply to people with less than good credit.
Cash advance fee
Cash advance fees mostly range from 2 % to 5% of the amount of cash being taken out, and it's often with a minimum amount, like $5. Issuers usually charge cash advance fees during those times when customers use all their credit cards to withdraw cash at an ATM counter.
Balance transfer fees
This is the fee you get once you transfer debt from one credit card to another, aiming for a lower interest rate. In these transactions, a person is mainly charged around 3% to 5% of the amount transferred.
However, there are some cards that do away with these fees, either from the beginning or over the course of a few days.
Late fees
Late fees are quite a typical affair, and most of us are acquainted with this, and we know that every time we fail our minimum amount before the due date, we are then likely to face a late fee. Even though there are some cards that waive the late fee, however, that can still affect credit scores.
Interchange fees
Interchange fees refer to the portion of a processing fee equal to a percentage of a transaction every time you use a credit card. This portion of the fee is sent to the issuer via the payment network and comprises around 1% to 3% of the transaction.
Interchange fees are set mainly by the payment network, and they vary on the basis of volume and transaction values.
How much Do Credit Card Companies Make?
As mentioned before, all credit card companies make enough money that adds to their profits. We can say this for sure, especially considering the fact that there are small transactions and other costs charged as well.
If you consider this deeply, you would see that this amount is not a small one as these days most Americans use credit cards, and the fees that we are referring to as small could quickly land up in millions.
How Credit Card Issuers make Money from Cardholders
Most of the time, we would think that the cardholders constitute the majority of profits for the credit card companies. However, we have to understand that the industry doesn't function like that all the time.
A majority of cards are diverse, and it's also a well-known fact that most of the card purchases by the card holders are the ones that are being paid for by the card issuer himself. As a matter of luck, now most savvy customers can avoid many of these costs.
See related: How to Build Credit at 18
List of Credit Card Companies
Undoubtedly, credit cards are one of the most popular forms of payment. And one of the main reasons for their popularity is that they are really convenient, easy to use, and help a lot with in-person transactions while shopping online.
Additionally, these are the kinds of cards that provide better consumer protection than debit cards. They issue offers like allowing customers to earn cash back, travel rewards cards, and various other kinds of points each time a person spends a dollar.
Credit card companies work even more smoothly in the United States, and if you have a good credit card balance, then nothing like it. According to the latest survey, around 41% of customers loved earning cash back each time they purchased something.
All things considered, it's essential for you to understand the various concepts of different credit card networks and issuers, how they function, and what is so unique about them.
When taking into consideration different credit card networks, you will see that there are specific key players in the market. Now, let's get to know them.
The United States has four key players in the credit card network. And they are:
- American Express
- Discover
- Mastercard, and
- Visa
Visa and Mastercard are the credit card networks that are most widely accepted everywhere across the globe.
See Related: Amex Gold vs Chase Sapphire Preferred
Advantages of Different Credit Card Issuers
The credit card industry has been dominated by the companies mentioned above. Now let's have a look at the different advantages of these credit card issuers and get to know the credit card processors in detail and their advantages.
American Express
One of the unique advantages of using American Express is that they let you earn cash back. And there are a lot of Amex cards that allow you to earn Amex Rewards points, which are pretty versatile and valuable.
Bank of America
The latest Nilson report says that Bank of America has the 7th largest card portfolio globally. One of the most important advantages of Bank of America is that they offer a wide range of awards for people with different credit profiles.
Also, holding a Bank of America credit card is beneficial if you already have an account in the company. When your qualified accounts reach a certain balance, you will be eligible for boosted credit card rewards.
Barclays
Using a Barclay card would allow you a lot of co-branded credit cards, along with travel brands like JetBlue, Carnival Cruises, Choice Privileges, and Frontier Airlines.
Capital One
Any type of consumer can avail of a range of credit cards. Capital One issues credit cards and charge card options for most businesses, cash-back credit cards, travel credit cards, secured credit cards, and several card options.
Citi
Citi has earned quite a reputation and offers one of the most popular cash-back credit cards today. It also lets an issuer earn points in the Citi ThankYou Rewards program. The card users can use this for cash back, gift cards, and traveling through the Citi portal.
Can a Cardholder Cut his Costs?
Sure, there are a lot of potential fees associated with credit cards, and there are a number of ways to save money. Please have a look as we enlist those.
Try Paying On-Time
Paying on time is essential, and one of the most important ways to do this is by prioritizing the monthly payments and making sure that your due dates aren't missed. One way to help you out is by setting pre-authorized payments online, which means you will never miss paying.
So, if you continue paying promptly, your credit score will be influenced, which is good.
Always Keep an Emergency Fund
Keeping an emergency fund is always essential and perennial. If you have a portion of the money reserved for any family emergency, you can do away with the stress of payments.
If you consider having an emergency fund from the beginning, you will see that many of your problems are being solved.
Try for an Affordable Credit Card
Choosing an affordable credit card as per your income is always advisable. Many mandatory fees are associated with one or two credit cards, so you must always choose wisely.
Of course, under no circumstances would you want to spend more money than required, and this would also need you to focus your energies on achieving your financial goals and the ones that matter.
In a Nutshell
In this article, we tried walking you through various steps and tried giving you a download of how credit card companies function and how they make money.
We have shown you how to start by paying your balance in full every month, which should be a constant practice. One of the easiest ways of doing this (like we mentioned before) is by setting up electronic alerts that will help notify you.
Next, you must also take care of your emergency funds. When there is economic uncertainty or a sudden family emergency, it's always better to be safe than sorry.
Lastly, we recommend that you pay an annual fee only if the rewards you will get from the card are likely to exceed the cost. While engaging in credit card transactions, you must never forget that all the rewards and sign-up bonuses can help you financially, but there is also an interest that comes along with it.
So, please choose wisely every time.
FAQ
Is it Essential for Everyone to Have a Credit Card?
No, it's not mandatory for everyone to hold a credit card, but you can enjoy a lot of facilities if you hold a credit card. For example, they allow you to earn cash back, and there are often exciting offers on your favorite amusement parks, clubs, and pubs.
Why Should Everyone Have an Emergency Fund?
No one can vouch for the fact that things will always be good and we will not be going through an economic turmoil. In order to avoid such mishaps, one must always try to have an emergency fund that will save him from a crisis.
Should you be Worried if you Have a Credit Card?
Actually, if you can try paying your bills monthly and on time, then there is absolutely nothing to worry about. It's when you fail to manage your money in an efficient manner, do problems arise.