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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.
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 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their credit card to get cash out of an ATM, the credit card company typically charges a fee between 2-5% of the cash withdrawn.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.
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.
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.
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.
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.