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How do credit cards make money

how do credit cards make money

A credit card allows borrowers to borrow money from their revolving credit account repeatedly. You can conveniently use credit cards to make large transactions that you repay through smaller monthly installments. But how exactly do credit cards make money? Learn how credit card companies profit by lending money. 

What Are the Two Types of Credit Card Companies?

A credit card company is an umbrella term comprising credit card issuers and credit card networks. Each credit card company has a different function, and they both make money differently. Learn about the differences below. 

Credit Card Issuers

A credit card issuer is a financial institution that provides money to eligible borrowers. Banks and credit unions offer credit cards, but so do retail stores. The credit issuer gives each borrower a credit limit based on their credit score and income. You can pay off the revolving debt in full or make smaller monthly installments. 

A credit limit is the maximum amount of money a borrower can spend. Borrowers spend their available balance by using a credit card in stores or online. However, borrowers can also withdraw cash at an ATM using their credit card for a small fee. 

Credit card issuers make their money by charging interest and additional fees. For example, if you withdraw cash using your credit card, you will typically have to pay a cash advance fee. 

Credit Card Networks 

A credit card network is an entity that processes credit card transactions and electronically moves money around. Some credit card issuers are also networks that lend money and process electronic transactions for consumers. 

Payment networks get their money from merchants instead of borrowers since they don’t directly give out credit limits. Merchants pay interchange fees to credit card networks to accept electronic payments from credit cards. Some merchants that accept credit cards require a minimum purchase amount to offset the cost of processing fees. 

Standard Fees Used by Credit Card Companies

Although credit cards are a valuable financial tool, they come with many fees you should know about. It’s important to be aware of the average credit card processing fees, and more. You may unknowingly be paying more for completing specific transactions. Learn about the most common credit card fees so you can minimize or avoid additional charges. 

Annual Interest Rate Fees

Credit card companies charge interest when borrowers carry a balance on their accounts. If you look at your cardholder agreement, the interest is shown as an annual percentage rate (APR). Credit cards have either a fixed or variable interest rate. Most credit card issuers have variable APR rates that change according to the prime rate. A good APR for a credit card is any interest rate below the national average. 

Balance Transfer Fees

A balance transfer fee is a charge for transferring debt from one credit card to another. When you transfer debt, you can take advantage of a low-interest credit card at the expense of a fee. The balance transfer fee is either a flat fee or 3% to 5% of the total transferred amount. Paying a balance transfer fee is only worthwhile when you know you can pay off the credit card debt before the end of an interest-free period.

Annual Fees

An annual fee is a fee you pay annually for having a credit card. Certain credit cards with exclusive benefits and features charge annual fees to cover service fees. Annual fees can range from $95 to $500. Depending on the card issuer, annual fees remain the same or change yearly. If you don’t want to pay an annual fee, you can easily find a credit card company that doesn’t enforce them. 

Cash Advance Fees

Credit cards are convenient because you can make purchases with them or use them to withdraw cash. However, withdrawing money with your credit card will result in a cash advance fee. Cash advance fees range from 3% to 5% per withdrawal. If your card issuer charges a 5% Cash advance fee and you take out $100 from the ATM, that’s a $5 charge. 

Foreign Transaction Fees

Suppose you travel outside the United States and use your credit card to buy high-end beauty products in Seoul. Your credit card company will likely issue a foreign transaction fee. Foreign transaction fees are typically 3% per transaction. If you spend $200 on Korean skincare products, you will pay about $6 in fees.

Late Payment Fees

You will be subject to a late fee when you pay your credit card late. Your first late payment is usually about $29. However, if you make multiple late payments, late fees may increase to $40! Multiple late fees can cost hundreds of dollars and decrease your credit score. Credit card options have no late fees, but you should always attempt to make minimum payments to avoid dips in your credit. 

Returned Payment Fee

Many people sign up for automatic credit card payments to avoid late fees. But the scheduled payment can bounce if insufficient money is in your bank account. Suppose your automatic payment is $200, but you only have $175 in your checking account. In that case, your scheduled payment will not go through. Returned payments will result in a returned payment fee, which is typically about $40.  

Over Limit Fees

Your credit limit is the maximum amount you can spend using your credit card. However, some credit card companies allow borrowers to exceed their spending limit. Thanks to the CARD Act of 2009, lenders need explicit approval from you to charge over-limit fees. If you want the ability to spend more than your credit line, you have to opt-in, or transactions that exceed your credit limit get declined. An over-limit fee can cost as much as $35, and you will also have to repay the money you borrow. 

Standard Fees Merchants Pay to Credit Card Companies

Businesses that accept credit card payments must pay numerous processing fees to credit card companies. The three main processing fees are interchange fees, assessment fees, and payment processing fees. 

Interchange Fees

An interchange fee is a merchant’s price to accept a credit card transaction. The cost of an interchange fee depends on the credit card company and the amount of the transaction. However, online credit card transactions are typically more costly since there is a higher risk of fraud. 

Assessment Fees

Merchants pay assessment fees to the credit card network to accept certain types of credit cards. The cost of an assessment fee depends on the number of sales a merchant makes. In the business world, a swipe fee is a combination of interchange and assessment fees. 

Payment Processing Fees

A payment processing fee is an amount a merchant services processor charges for facilitating transitions. Payment processors don’t make any money from interchange fees, so they charge service fees. Service fees include monthly, per-transaction, statement, and even equipment lease fees. 

How To Pay Less Credit Card Fees

Credit card companies charge a lot of fees, which can make the repayment process harder on borrowers. Millions of Americans struggle to pay off their credit card debt due to high-interest rates and high costs. If you want to pay less credit card fees, keep reading to learn how to pay off credit card debt aggressively

Use a Balance Transfer Credit Card

Are the rates on your current credit card astronomical? Consider applying for a balance transfer card! A balance transfer credit card allows you to transfer your credit card balance to a new account in order to get a more affordable interest rate. Many credit card companies offer a promotional rate for new applicants, so you may not have to pay interest for a brief period. If you can pay off your debt before the promotional period ends, the balance transfer fees may be worth the cost. 

Consolidate Your Credit Card Debt

Debt consolidation is when you use a large loan to combine multiple debts. Suppose you have multiple credit cards or accounts. In that case, you can use loans with monthly installments to get lower interest rates and fewer bills to pay. Personal loans typically offer lower interest rates than credit cards and fewer fees. Many lenders offer fixed interest rates, so you always know how much you need to pay each month. 

Use the Snowball or Avalanche Method

Two of the best budget plans to pay off credit card debt include the snowball and avalanche methods. The difference between the snowball and avalanche methods is the credit card you target first. The snowball method helps you focus on first paying off the credit card with the lowest balance. On the other hand, the avalanche method enables you to pay off the credit card with the highest interest rate first. The snowball method would be better if your interest rates were roughly the same across multiple cards. 

The Bottom Line

Credit cards have a lot of fees because of their convenience and features. If you are considering applying for a credit card, ensure you ask about fees prior to submitting an application. Many rewards credit cards have high costs to account for the additional features, so keep an eye out for annual fees and other expenses. Many credit card options have minimal fees, so take time to compare credit card companies. You’re sure to find the best financial option for your spending habits and budget!

References:
8 common credit card fees and how to avoid them│Select
How Do Credit Card Companies Make Money?│Experian
Credit Card Processing Fees│Forbes

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