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How Do Credit Card Companies Make Money? Here’s How

How Do Credit Card Companies Make Money? Here’s How

Credit cards are very powerful financial and credit tools, and they can either significantly help someone or hurt them in equal measure. They allow purchasing on sometimes staggeringly large credit lines, and if you pay them on time, they are a great way to get what you want while paying later. But just how do credit card companies make money if you don’t pay any fees or carry a balance month to month?

The short answer is that credit card companies have several ways that they make money. They make a significant portion of their money from the interest charged for financing, particularly consumers that pay higher rates. They also make money from fees, and interchange fees.

We’re going to take a closer look at just how the major credit card companies make money, even when customers don’t incur any late fees, penalties, interest, or other fees. We’ll dive into just where their income comes from, as well as how substantial that income is. Here’s everything you need to know about how credit card companies make their money.

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How Do Credit Card Companies Make Money If You Pay On Time?

Credit card companies can be quite different and so the answer to the question of how they make money can differ as well, depending on what kind of organization is being referenced. When people talk about “credit card companies” they are talking about either an issuer, or a network, and while they may seem similar at first glance they function very differently.

Issuers vs. Networks

Networks are the major companies that maintain the credit card infrastructure and process the transactions on infrastructure. These are entities such as Visa, American Express, and Mastercard. In some cases, like American Express and Discover, the company operates as both a network and an issuer.

Issuers are the credit unions and banking entities that issue the actual credit card. These are going to be companies like Chase, Capital One, Citi, and so on. Every time a credit card is used, it borrows money up to the predetermined credit limit from the issuer, to pay the purchase. Then the consumer is billed monthly for those purchases, under the APR and account terms of the credit card.

Closed-Loop vs Open Loop Credit Cards

Some issuers offer two types of credit cards, closed-loop, and open-loop, which function differently. Closed-loop credit cards will only be usable at specific stores or families of stores, for example, a Bed, Bath, and Beyond closed-loop credit card will only be usable at Bed, Bath, and Beyond locations, or associated stores. Open-loop credit cards may still earn the cardholder rewards as a closed-loop card would, but they can be used anywhere that cards from that network are accepted.

Open-loop credit cards will often have terms that give them an APR, or annual percentage rate for interest, as well as terms regarding late-payment fees and grace periods for considering payments late. Most open-loop credit cards are designed to facilitate carrying a balance, or not paying off your entire balance each month.

This differs for closed-loop cards, which often don’t allow carrying a balance and expect each month’s purchases to be paid off in full at the end of each statement period. They will usually have a much higher interest as well since they are often legislated and regulated differently than conventional open-loop credit cards.

Making Money – Where It All Comes From

Moneymaking starts even before goods are paid for, and it happens when the transaction is created and sent through the credit card networks. This not only generates the purchase approval or decline, but it generates a small amount of money for the network itself. The network is also the primary mechanism for ensuring that only legitimate and authorized purchases go through, so you aren’t the victim of fraud and so the card issuer can be sure they are billing you accurately for your purchases.

Interest

One of the major sources of revenue for all major credit card issuers comes from the payments they receive on carried balances that have interest applied to them. This is particularly true for issuers that operate in the subprime space, since they can charge incredibly severe interest rates, sometimes up to 25%.

Even though the Consumer Financial Protection Bureau states that most mass-market income is sourced from interest, interest is avoidable for cautious consumers. In most cases, credit card issuers only charge interest on balances carried month to month.

Fees, Fees, & More Fees

This is another area that generates incredible revenue for credit card issuers, particularly for those in the subprime credit industry, where the focus is largely on people that have less-than-optimal credit. These subprime credit issuers will typically rake in much more money from fees because of the rate structure that they build for their subprime market consumers.

Many cards have annual fees that cannot be opted out of and are charged automatically to the card each anniversary. Sometimes these fees are a good value for high-reward cards, but sometimes they are just more fees for people that are often trying to rebuild credit.

Cash advance fees are another incredibly effective way that card issuers make money because it automatically charges a percentage of the advance. Even with a relatively low fee of 3%, a cash advance for a $200 dinner becomes $206 and is subject to much higher interest rates than a normal point of sale purchases.

Late fees are fees charged to customers who make their monthly payments late. Many card issuers will have a grace period, 7 days for example, after the due date for people to make their payment technically late but still avoid fees. However, if paying after that date there will be additional fees involved, for example, if your payment is due on the 20th and you don’t pay until the 30th, you may be subject to a late fee. Some issuers will charge a flat fee, such as $35, for a late fee regardless of the balance due, and some issuers will include terms like “$35 late fee, or 5% of the balance, whichever is greater” which can mean huge penalties for big bills being paid late.

Balance transfer fees are another way that issuers make money, though they are less commonly used. When you open a credit card, you may have a lower APR than another card that has a balance, and moving that balance from one card to the other can save you interest payments. The card the balance is being transferred to may charge a balance transfer fee, frequently a percentage of the balance, to assume the debt. They may also waive the fee, or offer a promotional balance transfer APR. It will all depend on the issuer and the card.

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Interchange Fees

The issuer and the networks make a share of every transaction that is processed on the networks. This can range from a fraction of a percent to as high as 3% of the total transaction value in some cases. These fees are put in place by the payment networks themselves and are often variable based on the value and density of the transactions created by the business.

More like this: What Is an Unsecured Credit Card? Secured Vs. Unsecured Cards

Using Your Credit Card Effectively, And With Minimal Fees

By being a conscious and aware cardholder you can avoid paying serious interest and fees. While you won’t make your credit services cheaper, you can help limit the amount of money that the companies make from you specifically. Do what you can to limit the damage by:

  • Setting balance and payment alerts for all of your credit accounts
  • Pay your balance in full to completely avoid late payment and interest charges
  • Choose a credit card with no annual fee
  • Set some money aside to pay for emergency expenses that would otherwise need a cash advance

How Much Money Do Credit Card Companies Make?

For the second quarter of 2021, credit card companies posted incredible amounts of revenue. American Express posted revenue of more than $10 billion, Visa posted revenue exceeding $6 billion, and Mastercard posted revenue that totaled more than $4.5 billion. This is for just one quarter out of the fiscal year 2021. In 2020, the interchange fees alone accounted for $51 billion, and the revenue generated from interest fees topped $76 billion for the year.

Also read: How To Make Money While You Sleep 

How Credit Card Companies Make Their Money

Credit card companies may seem fairly intangible to most people, being an entity that extends credit, many times for no money in return. This does make credit cards potent credit products, but it also opens up the consumer to a host of potential fees and interest charges on the purchases they make.

Regulatory bodies and legislation have outlined that all of the pertinent financial information be clearly presented to the consumer, but in many cases, people aren’t even aware of what types of fees they may face if their payment is late or if they take a cash advance. Those fees can be significant, and they’re what keep the credit card companies going.

Final Take

One way or another credit cards and the banks that offer them will benefit, the best thing you can do as a smart credit card user is to plan your expenses, pay on time to avoid interest charges to pile up, and make sure to get the most from the card you choose.

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