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I use my credit card for virtually all of my purchases. Since Personal Capital tracks all of my credit card purchases, I am easily able to stay within my monthly budget. Plus, you won’t hear me complaining about the 1.5% cash back I receive from my credit card.
Since I’ve always paid off my credit card balance, I always assumed that credit card companies didn’t make any money off of me.
Unfortunately, I was wrong.
How Credit Card Companies Make Money
Credit card companies make their money through four main ways.
- Fees charged to credit card holders,
- Interest paid by credit card holders that don’t pay off their balance each month,
- Transaction fees paid by businesses that accept credit cards, and
- By selling your information.
Let’s take a deeper look into each of the ways that credit card companies make money off of you.
Consumer Fees
While merchant fees and interest make up a large portion of a credit card company’s revenue, credit card companies also collect fees from their customers, which often include annual fees, cash advances, balance transfers, over limit fees, foreign transaction fees and late fees.
Annual Fees
Annual fees are fees that the consumer must pay on a yearly basis. These fees are typically associated with high-reward credit cards or credit cards awarded to people with poor credit.
Cash Advance Fees
When a credit card user uses their credit card to get cash out of an ATM, the credit card company typically charges a fee between 2-5% of the cash withdrawn. Normally, the minimum fee is $5.
Cash advance fees usually have differing interest rates than your normal interest rate, which is often much higher- typically over 20%.
Balance Transfer Fees
This might occur when you move from a high-interest credit card to a lower-interest one. A lot people will try to transfer into introductory 0% credit cards, but you’ll usually be charged 3-5% of the amount transferred, although some cards will waive the fees for a certain amount of time.
Most people do not pay off their balance before the teaser rate is over. In that case, they can end up paying an even higher interest rate than their previous card.
Overlimit Fees
If you exceed your credit card limit, you will be subject to a overlimit fee. However, the Consumer Financial Protection Bureau has provided guidance that says that you can go over your credit card limit if you have provided your credit card company with permission to do so.
Foreign Transaction Fees
If you plan to travel overseas, check with your credit card to see if you will have to pay foreign transaction fees. These fees can quickly add up if you are not careful. I specifically sought out a credit card that offers free foreign transaction fees for when I travel.
Late Fees
When you fail to pay the minimum balance amount by the due date, you may face a late fee. Some cards, however, will waive the late fee the first time that it happens. Per the Credit Card Act of 2009, the fee for a first-time late payment is $27. The fee rises to $38 if you make a late payment more than once during a 6-month period.
Some credit card companies will raise your interest rate after even one late payment. The good news is that it only applies to new purchases. If you’re not happy with the increase in interest rate, you can pursue another credit card or method of payment.
Interest
Credit card companies make most of their money off of interest, with the average annual percentage rate (APR) on all credit cards at 15.18%. However, beware of retailer credit cards, which average an APR of 23.84%.
The average US household that has debt has more than $16,061 in credit card debt (source: NerdWallet). Therefore, the average US household spends almost $1,400 a year on credit card interest, if they pay it off within a year. This amount almost doubles to $2,700 if you take two years to pay it off. As you can see, time is of the essence when it comes to paying off your credit card debt.
Typically, you only pay interest when you carry a balance from month to month. But of course, you can avoid paying interest if you pay off your credit card balance each month.
While most consumers like to think that credit card companies prefer to charge their customers more in interest, that’s actually not true. Credit card companies want you to continue swiping your card as much as possible so that they can earn 2-3% from the merchants, which is essentially risk-free to them.
If you hit your credit limit, credit card companies have to wait for you to pay off your balance. There is the chance that you’ll potentially default down the line, which obviously hurts their bottom line.
Transaction Fees
When you purchase an item using a credit card, a small percentage of that purchase (usually 2-3%) goes to the credit card companies through interchange fees.
The broad term “credit card companies” includes two kinds of enterprises: issuers and networks.
The issuers are the banks and credit unions that issue the credit card (e.g. Capital One or Citibank). They are the entities that you are actually borrowing the money from when you make a purchase.
The networks are companies that are associated with managing the card (e.g. Visa or MasterCard). These networks receive a portion of the fees.
American Express and Discover actually act as the issuer of the credit card and the network, which is known as “closed-loop” network.
In contrast, Visa and MasterCard operate on an “open-loop”, which means that they connect to the two financial institutions.
How do interchange fees affect you?
When a merchant must give up 2-3% of their sales, goods are marked up to make up for it. While somewhat dated, a report done in 2010 by the Federal Reserve Bank of Boston found, “On average, each cash-using household pays $149 to card-using households and each card-using household receives $1,133 from cash users every year.”
Interestingly enough, they continue, “On average, and after accounting for rewards paid to households by banks, the lowest-income household ($20,000 or less annually) pays $21 and the highest-income household ($150,000 or more annually) receives $750 every year.”
Clearly, the costs of credit cards even affect cash-using consumers.
Why can the credit card companies charge such high rates?
They act as an intermediary for all the parties involved in the transaction: the merchants, cardholders, and the issuing banks. They handle the transaction behind the scenes, like the secure financial transfers from the bank to the merchants.
Selling Your Information
Do you ever get what seems like junk mail with a bunch of legal jargon from your credit card company? Sometimes in the fine print, the legal jargon discloses their right to sell your information unless you tell them that they cannot.
Some credit card companies choose to sell this customer data to other businesses. This may alarm you, but they sell the aggregated data anonymously such that companies cannot single you out. On top of that, the companies that buy your data aren’t interested in specifics, as much as your buying trends and habits. They would focus more on your tendencies of whether you spend more money buying groceries or eating out at restaurants.
Credit card companies clearly make a lot of money off of each one of us, whether you pay off your monthly balance or not. As consumers, we should know how exactly companies make money off of us and if we feel comfortable with the tradeoffs.
I didn’t realize that they sold my information, but I’ve long since closed my credit card accounts when I realized that for many purchases we make we can get a good 5% discount off the price if we paid cash (not check, cold hard cash). That beats the 1-2% cash back any day.
The only purchases we can’t get discounts for cash on are from our grocery store and online purchases like Amazon and our internet service provider.
Plus, it really does feel great not to have any debt whatsoever – even a tiny amount that we paid of each month.
Thanks for letting us know they sell info – we’ll never go back!
Thanks for stopping by Wes!!! Yeah I have to admit that I was unfamiliar with them selling my information. I knew they did some of the other stuff but man selling my info, especially with the lack of privacy got me thinking…
Nice review. Especially the transaction fee explanation and graphics. I suspect followers of this blog are similar to me in that:
1) I use a cash rebate card (Discover) and get back more than 1% rebated back in cash from my purchases. 2) Use card for all purchases, but never carry a balance. Doing these actions allow me to use the credit card company’s cash and turn a little profit on my purchases. Tom
Tom @ Dividends Diversify recently posted…Get Your Motor Runnin’
Thanks for sharing Tom!!! Like you I love using my card back to get cash back rewards as well as paying it off each month. No point in giving the credit cards more money than I have to 🙂
Wow this is super interesting! I could kind of guess those CC companies make money off of fees and interest, not selling our information.
I guess we can turn almost anything into money nowadays. At lease the data are aggregated and doesn’t show our personal info @_@
Ms. Frugal Asian Finance recently posted…5 Things I Stopped Doing After Launching My Blog
It’s amazing how much information is being generated from data these days. I feel like the most valuable companies are those that have the most data these days 🙂
While I knew this it’s a great reminder. Nothing in life is free. Someone’s always paying the bill. If you don’t understand how it might be you.
Hahaha…great points Full Time Finance!!!
I am aware of the charges that financial institutions charge the merchants that you buy your items from. However, I am pretty surprised that cash users are subsidizing the card users.
Fortunately for me, I am a card user and I always pay my bills on time. I am also not complaining about the 1.75% that I get in reward and cash back. Because of my discipline with my money, I think that I am actually benefiting from using my credit cards.
Leo T. Ly @ isaved5k.com recently posted…Personal Finance Horror Stories
Like you Leo I definitely like to think that I am coming out on top when it comes to credit cards, although I’m a little unclear of how the data they’re selling could be potentially used against me in the future.
The beauty of this is that most of the fees can be avoided. If you use credit wisely and optimize rewards you can come out way ahead. That’s what Winning Personal Finance is all about. Unfortunately, so few people make the right credit decisions that the credit card companies are able to print money!
Jason@WinningPersonalFinance recently posted…Chasing Financial Independence is NOT About Sacrifice
Absolutely Jason!!! I definitely wish more people were savvy when it came to credit cards. Once you get in the hole it’s awfully hard to start digging out of…
Great point about credit card use affecting cash users as well. Merchants will most definitely raise the cost of goods to cover transaction fees. Why pay for it themselves when they can pass it along to the customer?
Mike from Budget Kitty recently posted…Halloween Safety Tips Every Parent Needs To Know
Exactly…I have a hard time believing that merchants are going to eat the costs of transaction fees along the way. Customers are going to pay for it, whether they use it or not.
The rates charged by some credit cards are nearly criminal. When we were getting engaged, I was shocked at the 25% interest rate credit cards jewelers were peddling. Thank you for mentioning that they make moolah on your personal information, because that is so true! Even if, like us, you pay off your card each month, the credit card companies can still make money on you.
Mrs. Picky Pincher recently posted…What A Frugal Week At FinCon!
25% interest rate for jewelry credit cards is awful. I hate how they sweet talk you with jewelry, especially when you are in love, and then conveniently slide a credit card with an exuberant credit card rate on top of that when they know you can’t afford it.
The transaction fees by businesses are one that will apply to a lot of small businesses. They try to only accept cash and will only take CC if it is a minimum amount you purchase. This is true at the deli at my work, so the rare times I do go there I always pay in cash 🙂
SMM recently posted…We Should Stay In Our Financial Lane
Hahhaha…I definitely hate the minimum amount to purchase but it totally makes sense why they want/need to do it. Otherwise with such razor thin margins they would get eaten alive.
Nothing new here for me.
I think some credit card companies have an “opt out” for selling your information to third parties. There is no opting out of your credit card company sharing your information with their affiliates and contractors.
Also, the 2%-3% transaction fees seem too high. In actuality, the fee for use of their network is a combination of a per transaction fee (flat fee) and a percent of the dollar amount which goes down as volume increases. Your major retailers are paying a lot less 2% because they do so much volume. Even small retailers are paying less than 3%. I recall Visa lost some monopoly lawsuit on this issue a few years ago and fees have tumbled since then.
re: price differentiation for cash vs. credit. I have not tried this. I know that in the 1990s the standard credit card agreement with merchants specified no price differentiation. The credit card companies would occasionally run sting operations where they would catch merchants giving a cash discount. They would send a cease & desist letter to those merchants. Of course now gas stations advertise the price difference. Still, I think the price differentiation clause is still in effect for most retailers. Otherwise, they would all advertise a cash discount.
There was a lawsuit a year or two ago against these vendors. They lost thus rendering the price differentiation punishment unenforcable. It’s still not a widespread practice.
FullTimeFinance recently posted…Choices for Open Enrollment
Thanks for the clarification FTF!!!
I recall this now. The key point I took away is really just a matter of semantics and revolve around the terms discount vs. surcharge. Gas stations are imposing a surcharge for using credit cards not a discount for using cash. If the cash price is $1.90 and the credit card price is $2 what difference does it make if you say the credit card is being assessed a $0.10 surcharge or the cash payment is being given a $0.10 discount? None but retailer are allowed to impose a credit card surcharge but not allowed to give a cash discount. 6 of one, half a dozen of the other…
Wow that’s crazy that they use to run stings back in the day. I had no idea!!! Thanks for sharing Dan!!!
Thanks for this great information Rob. Like you, we use our points card for almost all of our purchases. We also pay the balance off every month. I am now going to have to do some research if we are being challenged with any hidden fees.
Dave recently posted…Keep Your Hands Off My 401K
Thanks for sharing Dave!!! I definitely think that having a credit card is beneficial if you can pay it off each month and you’re aware of the some of the negatives. It’s definitely something I’m glad I have.
Great article. I just learned about how the credit card companies make money while doing a case analysis as part of my MBA. So I clicked on this article expecting to know everything, but selling customer information wasn’t included in the case analysis. Thanks for the insight!
I think selling my information bothers me less than many people. It provides those businesses with more information to direct more relevant marketing to me. It might bother me more if the information wasn’t aggregated though.
Glad you enjoyed it Zack!!! I am definitely glad the info is aggregated but then again with how good data mining is I wouldn’t be surprised if people couldn’t figure things out with the right technology.
Let’s try to find the positives…..Many of us probably have Visa or Mastercard stocks in our retirement funds that are doing quite well 🙂
Mr Defined Sight recently posted…How To Live Your Life With No Regrets
Hahahah… I can always depend on you for the positive 🙂
I use a credit card to get gift card rewards . I pay off my balance every week. I don’t buy an item if I don’t have the money in my bank account.
Thanks for sharing Steven!!! We are definitely similar in paying off the credit cards and not buying something that we can’t afford 🙂
Wow, I did not know about the selling of information portion. But overall I still feel that credit cards have their usefulness although I would only recommend credit cards to disciplined users. The late fees and interests from a few months of credit card debt easily offsets any benefits you gain from using the card.
Thanks for sharing Terence!!! I definitely agree at this point the pros of credit cards outweigh the cons 🙂