How Do Credit Card Companies Make Money?

Understanding how credit card companies make money is crucial for savvy financial management. This article sheds light on the mechanisms behind their earnings and emphasizes the role of informed credit use in minimizing costs. Let’s learn how to navigate these waters and keep more money in your pocket.

How Do Credit Card Companies Work?

In the simplest terms, one of the primary ways credit card companies work by giving users access to lines of credit for spending and advances.

Credit card networks provide the service of processing credit-based transactions, and consequently processing fees and interest fees connected to user accounts on behalf of lenders, or credit issuers.

These networks also process transaction fees from merchants, who must pay for the right to process credit card payments over a given payment network.

There are four major networks or credit card processors: Visa, Mastercard, Discovery, and American Express. Each of these networks is responsible for the processing and technical aspects of facilitating credit card transactions for which they earn money by charging processor fees and other fees. 

According to Experian, two of these networks, Discovery and American Express, also function as credit card issuers. Card issuers are the financial institutions responsible for providing the funds to back credit card purchases.

Visa and Mastercard function only as networks or credit card processors, and work in direct partnership with credit card issuers such as Chase, Citi or Capital One. In this equation, the card holder is essentially a borrower with the responsibility to repay a loan to the card issuer.

How Do Credit Card Companies Make Money?

How do credit card companies and banks make profits? For starters, credit card companies make their money through a combination of fees charged (including interchange and assessment fees), interest, and merchant fees. 

Fees

Most credit card accounts come with an array of both inbuilt fees and fees related to certain types of transactions. The fees that you pay will usually be specific to your type of account. For instance, those credit card users with poor credit may pay higher fees for access to credit spending.

Alternatively, credit card offers with generous rewards programs may also charge higher-than-average fees. The most common types of fees include:

• Annual Fees: Some credit offers come with annual fees, especially accounts with generous rewards and benefits, and accounts made available to “subprime” borrowers with subprime credit cards, or those with poor credit. 
• Penalties For Late Payment: A common credit mistake, is failing to pay your monthly bill on time which will typically result in penalty fees or a late fee. In 2020, $12 billion, or 7 percent of total credit card revenues came from penalty fees or late fee.
• Balance Transfer Fees: Though some cards may offer 0% interest repayment promos that make them attractive for balance transfer, this transfer may come with a processing fee which most people would view as balance transfer fees.
• Cash Advance Charges: Getting an advance will typically be the costliest credit card transaction you’ll make. Companies like AmEx offers cash advances, which are typically high fees, and may include both a flat fee and a percentage-based fee per transaction as well as a heightened interest rate for repayment.  

Interest 

Nerdwallet notes that the vast majority of the revenue earned by credit card issuers comes from interest payments. The Consumer Financial Protection board notes that this is where credit card companies draw their greatest profits.

In essence, credit cards serve as a source of lending. As with most loans from financial institutions, you must pay interest fees on your principal loan balance. The rate of interest will depend on your credit card offer. In many cases, the better your credit score, the lower the borrower interest rate for which you will qualify. 

According to Value Penguin, “The periodic rate is the annual percentage rate (APR) divided by 365. In the United States, the average credit card interest rate paid by interest-bearing accounts is 19.33%.”

The good news is that this rate is based entirely on the balance that you carry forward every month. So the lower your credit card balance, the less you’ll pay in interest. In fact, you can avoid interest charges altogether by paying your balance down in full, on time, every month.

Of course, there is substantial numerical evidence that many credit card users do carry balances forward from month to month. This results in handsome profits for the credit card issuer. Chase Bank alone cleared more than $51.66 billion in interest in 2019. 

Merchant Charges

Value Penguin notes that, behind interest charges, merchants pay fees that amount to the second greatest source of revenue for credit card companies. Every time a merchant accepts a credit card payment, a percentage of that sale is transferred directly to the card issuer.

This is referred to as the interchange fee. This fee constitutes an enormous source of profit for card issuers every year. Once again at the top of the list, credit card issuer Chase Bank pulled in well over $20 billion through interchange fees in 2019, according to Value Penguin.

How Do Credit Card Companies Make Money From Merchants

I’ve discussed the way credit card companies make money from cardholders. Yet, that’s not the only way they make money. Merchants, the businesses which accept credit cards from consumers to make purchases, also contribute to the profitability of credit card companies through the following fees: 

Interchange Fees

Interchange fees are major fees that make up a huge portion of the revenue credit card companies earn from merchants. These fees are charged to merchants every time a customer uses a credit card for a transaction, and are typically a percentage of the transaction amount.

The interchange fee is shared between the credit card issuers (bank or credit union) and the credit card network.

Interchange fees vary based on the type of card used -debit card (for use where merchants accept debit cards), credit, or rewards- and the type of merchant -small business, medium sized, or large corporation. The other fee worthy of mention is the assessment fee (sometimes a flat rate assessment fee) which goes wholly to the credit card associations.

Processing Fees

Processing fees are another significant source of income for credit card companies. These fees cover the cost of processing transactions, including authorization, settlement, and other related services. Merchants are charged a fee for each transaction processed through the credit card network.

Processing fees can vary depending on the card network or the type of transaction -card-present vs. card-not-present. 

Additionally, the payment networks may offer value-added services to merchants, such as fraud prevention tools, chargeback management, and analytics solutions. These services often come with an additional cost, contributing to the credit card company’s revenue stream.

Annual and Membership Fees

Some credit card companies offer co-branded credit cards in partnership with merchants or brands. They often charge annual fees or membership fees that are paid by cardholders (cardholder fees). 

A portion of these fees may be shared with the merchant as part of the partnership agreement. This revenue-sharing model benefits both the credit card company and the merchant, creating a symbiotic relationship where the merchant gains access to a broader customer base, and the credit card companies earn money from fees.

How Can You Spend Less on Credit Cards?

So that’s how credit card companies make their money. But what can you do to avoid becoming a major contributor to your card issuer’s bottom line? There are some key steps that you can take to build credit while keeping more money in your pocket:

Minimize Fees

Look for credit card offers with minimal fees. Find an offer for a card with no balance transfer fees or annual fees. Nerdwallet makes an exception here though, advising that you should only apply for a credit card offer with an annual fee if “the rewards you’ll get from the card will exceed the cost. 

Remember that rewards and sign-up bonuses can put money in your pocket, but card transaction fees paid and credit card interest fees can eat right through it.” Do the math before choosing a high-rewards cards with a high-fee. If you can, avoid foreign transaction fees as well. 

Don’t Carry a Balance

Always pay your balance in full and on time every month. This is the easiest way to avoid interest. If you must carry a balance, be sure that you pay more than the minimum due each month. Naturally, the lower your balance, the less you’ll pay in interest.

Stay Away from Cash Advances

Once again, the advance is likely the most expensive transaction you can make using a credit card. The fee structure surrounding advances is designed to be onerous. 

You may pay both a flat transaction fee for receiving an advance and an additional percentage-based fee (usually between 2-5%) on the total sum borrowed. Not only that, but you would likely also pay a higher interest on the resulting balance than you would on a credit card purchase balance. Cash advances should be avoided in all but the most desperate situations. 

Have Good Credit

This is the number one thing you can do to minimize the amount that ultimately goes from your pockets into the deep coffers of credit card networks and issuers. Credit cards that offer 0% interest promotional repayment periods typically reserve these offers for borrowers with good to excellent credit scores. 

The same is true for credit card offers with extensive rewards programs and $0 in annual fees. A borrower with a lesser credit score will typically have a lower credit limit and be limited to credit card offers with higher interest rates on repayment, annual fee, balance transfer fee, and foreign transaction fees. There would also be over limit fees.

Related Questions

Conclusion

While it’s easy to suggest having good credit, it’s a lot harder to actually achieve it if you’ve struggled to pay down balances, manage credit card debt, or stay on payment schedules even with automatic payments in the past.

So before you even consider opening a new credit card, I would strongly advise taking a few important steps to improve your qualifications for attractive offers. Jump from here to my guide on How to repair your credit rather than just transfer debt.