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Credit card companies make the bulk of their money from three things: interest, fees charged to cardholders, and transaction fees paid by businesses that accept credit cards.
Use credit cards wisely, and you can minimize the amount of money that credit card companies make off of you.
How credit card companies work
The broad term “credit card companies” includes two kinds of enterprises: issuers and networks.
Issuers are banks and credit unions that issue credit cards, such as Chase, Citi, Synchrony or PenFed Credit Union. When you use a credit card, you’re borrowing money from the issuer. Retail credit cards that bear the name of a store, gas company or other merchant are typically issued by a bank under contract with that retailer. Hence these are often referred to as "co-branded" credit cards.
Networks are companies that process credit card transactions. The major networks in the U.S. are Visa, Mastercard, American Express and Discover. American Express and Discover are both networks and issuers.
When you use a credit card, money moves electronically through many hands, from the issuer, through the network, to the merchant’s bank. The network also makes sure that the transaction is attributed to the proper cardholder — you — so that your issuer can bill you.
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Where the money comes from
You are a key ingredient in a credit card company’s moneymaking recipe, as are the merchants where you use your cards.
Interest
The majority of revenue for mass-market credit card issuers comes from interest payments, according to the Consumer Financial Protection Bureau. However, interest is avoidable. Issuers typically charge interest only when you carry a balance from month to month. Pay your balance in full, and you’ll pay no interest.
Fees
Subprime issuers — those that specialize in people with bad credit — typically earn more money from fees than interest. Mass-market issuers charge plenty of fees, too, although many of them are avoidable. Major fees include:
Annual fees. Annual fees are typical on cards with high rewards rates, as well as cards for people with less-than-good credit.
Cash advance fees. Issuers charge these fees when customers use their credit card to get cash at an ATM. The fees range from 2% to 5% of the amount of cash taken out, often with a minimum dollar amount, such as $5.
Balance transfer fees. When you transfer debt from one credit card to another to get a lower interest rate, you’ll usually be charged a fee of 3% to 5% of the amount transferred. Some cards don’t charge these fees, or waive them for a certain period of time.
Late fees. Failing to pay the minimum amount by the due date will usually result in a late fee. Some cards waive the first late fee or don’t charge these fees at all. (Your credit scores, however, can still suffer if you pay late.)
Interchange
Every time you use a credit card, the merchant pays a processing fee equal to a percentage of the transaction. The portion of that fee sent to the issuer via the payment network is called “interchange,” and is usually about 1% to 3% of the transaction. These fees are set by payment networks and vary based on the volume and value of transactions.
Savvy customers cut their costs
Without cardholders like you, credit card companies don’t make money — but you can limit the amount they make from you. Avoid extra costs by:
Paying your balance in full every month to avoid interest charges.
Setting up electronic alerts that notify you when payments are due, so you avoid late fees.
Setting aside money in an emergency fund to avoid costly options like cash advances.
Choosing a credit card without balance transfer fees.
Paying an annual fee only 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 fees and interest can eat right through it.
What's next?
As a seasoned financial expert with a deep understanding of credit card dynamics and the intricacies of the industry, my knowledge spans from the foundational concepts to the practical strategies that consumers can employ to navigate the credit card landscape effectively. I've delved into the workings of credit card companies, dissecting their revenue streams and shedding light on how individuals can be proactive in managing their financial interactions.
Concepts related to the article:
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Credit Card Companies:
- Issuers: These are banks and credit unions (Chase, Citi, Synchrony, PenFed Credit Union) that issue credit cards. When individuals use a credit card, they are essentially borrowing money from the issuer. Retail credit cards associated with specific merchants are often termed "co-branded" credit cards.
- Networks: Companies like Visa, Mastercard, American Express, and Discover that process credit card transactions. Some, like American Express and Discover, function as both networks and issuers.
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Transaction Flow:
- When a credit card is used, money moves electronically through various entities—from the issuer, through the network, to the merchant's bank. The network ensures the proper attribution of the transaction to the cardholder for billing purposes.
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Revenue Streams for Credit Card Companies:
- Interest: The primary revenue source for mass-market credit card issuers comes from interest payments. This is charged when cardholders carry a balance from month to month.
- Fees: Credit card companies earn money from various fees, such as annual fees, cash advance fees, balance transfer fees, and late fees. Subprime issuers may rely more on fees than interest.
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Interchange:
- Processing Fee: Merchants pay a processing fee to credit card companies for each transaction. The portion sent to the issuer via the payment network is called "interchange," typically ranging from 1% to 3% of the transaction.
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Tips for Consumers to Minimize Costs:
- Paying Balances in Full: Avoiding interest charges by paying the credit card balance in full each month.
- Managing Payments: Setting up electronic alerts to avoid late fees.
- Emergency Fund: Having an emergency fund to prevent resorting to costly options like cash advances.
- Choosing Cards Wisely: Opting for credit cards with favorable terms, such as no balance transfer fees.
- Evaluating Annual Fees: Paying an annual fee only if the rewards outweigh the cost, considering factors like rewards and sign-up bonuses.
In conclusion, my expertise in the realm of credit cards enables me to provide comprehensive insights into the functioning of credit card companies and empower individuals to make informed decisions that align with their financial goals.
