How Do Credit Card Companies Make Money?

Credit card companies make money from interest and fees charged to cardholders and from transaction fees paid by businesses that accept credit card payments. Once you understand this, you may be able to find ways to better understand how they report credit, what products and services they charge for, and how you can work with them to your mutual benefit.

About Credit Card Companies

There are two types of credit card companies: card issuers and card networks. Some companies, like Discover and American Express, are both issuers and networks. If you have a credit card or expect to have one, you should understand the difference between them.

The credit card issuer is the bank or credit union that issues you the card. Credit card issuers are responsible for most of the functions that directly affect card users.

  • The issuer is responsible for processing, approving or denying your credit card application.
  • Your credit limits, interest rates, rewards, and the other terms that govern your account are set by the issuer.
  • The issuer collects payment from you and pays the merchants when you make purchases with your card.
  • Issuers handle customer service and dispute resolution.

Some issuers may partner with another business, like a hotel chain or airline, to create special-purpose cards.

Credit card issuers make money from cardholders by charging them fees for the use of their cards and by charging interest on balances carried from one month to the next. Issuers also receive an interchange fee from the merchant every time you use your card.

Credit card networks, like Mastercard and Visa, provide the technological backbone that supports credit card transactions. Credit card networks work closely with the merchants who accept credit cards.:

  • Credit card networks control where cards are accepted. Some merchants will only accept cards from certain networks.
  • Networks set the fees that merchants pay each time a customer uses a credit card.
  • Networks process the credit card transactions and manage all transactions between merchants and card issuers.

Credit card networks earn money by charging merchants a network fee for each transaction they accept.

As a cardholder, you will almost always do business with the card issuer. If you’re a merchant that accepts cards, you will engage primarily with the card network.

How Credit Card Issuers Make Money From Cardholders

Credit card issuers have three main ways of making money from their cardholders: annual fees, miscellaneous or penalty fees, and interest.

An annual fee is a yearly payment that you make to own and use the card. It is a fixed fee and does not change. Not all credit cards have annual fees. Cards with high rewards and cards for users with bad credit usually have the highest fees.

Annual fees are listed on your credit card application, so before applying for a card you should check to see whether there is an annual fee and how large it is. If you already have a card, your cardholder agreement will tell you what the annual fee is.

Miscellaneous and penalty fees are charged for specific types of transactions and situations. Cash advance fees, over-limit fees, foreign transaction fees, balance transfer fees, and late payment fees are all examples of this type of fee.

These fees are also listed in your cardholder agreement. If you know what fees are associated with your card you can manage your card use in a way that minimizes spending on fees.

Interest is charged on any credit card balance that isn’t paid by the end of the billing period in which it was charged. The interest on a credit card is expressed as an Annual Percentage Rate (APR) and may vary depending on your credit and other factors.

APRs on many cards may be quite high, considerably higher than the interest rates on most loans. In some cases, late payments will trigger higher interest rates as a penalty. You should know the APR on each of your cards and be aware of any penalty clauses that could raise your rate.

Understanding these costs will help you control them and reduce the amount you pay to use your credit card.

How Credit Card Companies Profit From Merchants

Credit card networks collect a fee for every credit card transaction a merchant processes, often between 1% and 3% of a transaction’s value. Merchants pay these fees for the ability to offer their customers the convenience of credit card transactions. Think about that: every time someone swipes a card at the register that merchant pays a percentage of that transaction to the processing network.

The fee paid by merchants is divided into two parts.

  • The network fee is retained by the credit card network.
  • The interchange fee is collected by the network but paid to the issuer.

Interchange fees give card issuers an incentive to keep you using your card. That’s why they offer points and other rewards. The more you use that card, the more money they earn.

How to Minimize Your Credit Card Costs

Here’s how to cut your credit card costs.

Check the annual fees on all of your cards. Most cards with high annual fees offer potential benefits like points or cashback offers. You should understand what these benefits are and make sure you’re taking advantage of them. If you aren’t using the benefits, consider moving to a card with a lower annual fee or no fee at all.

For example, if you have a card with a high annual fee but high rewards, work out the value of the rewards you receive. If you are earning more in rewards than you pay for the card every year, you’re getting a good deal. If the rewards are below the annual cost of the card, you might want to consider using a different card.

Avoid miscellaneous and penalty fees by knowing what fees can be charged on your card and avoiding transactions and situations that can trigger fees. Read the cardholder agreements for all your cards, note the fees, and use your cards strategically to avoid them.

Credit card companies earned $26.6 billion in cash advance fees and $12 billion in penalty fees in 2016. If you keep the money you need for daily use in a debit card account and avoid incurring penalties, you will not be contributing to those totals.

Eliminate interest costs by paying your balance in full every month. Avoiding interest is simple, if not always easy. If you pay your balance in full every month you will pay no interest at all.

If you have to carry a balance, make sure you do it on the lowest-interest card you have. Pay off the balance as soon as you can and avoid situations, like late payments, that might trigger penalty interest rates.

If you choose the right cards and manage your card use carefully, you can have the convenience of a credit card and the use of the card issuer’s money – essentially a short-term loan – at no cost to you at all.

Don’t Pay More Than You Should for Your Credit Use

Credit card networks and issuers make money every time someone uses their cards. You contribute to their bottom line every time you swipe. That isn’t a problem for you, because those fees are paid by the merchants.

Credit card issuers also make very large sums of money from people who carry large balances and never check their fees or try to avoid fees. You don’t have to be one of those people. If you pay your balance in full every month you will never need to pay interest to your issuer. If you choose your cards wisely and stay aware of their fees, you can minimize or eliminate fee payments. That gives you all of the advantages of a credit card at little or no cost.

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