If you want to understand credit, it’s more than just knowing how credit cards work, it also includes knowing how credit card companies make a profit. Credit card companies make money by collecting interest, merchant transaction fees, and fees charged to cardholders. When you understand how each of these factors works and how they affect you as the cardholder, you can be sure that you’re getting the best deal available on a credit card.
Interest Income for Credit Card Companies
The profitability of credit card operations is primarily due to income generated by credit card companies through interest fees. Any time a credit card has a remaining balance after payment is due, the remaining balance gains interest. The interest is charged at the card’s annual percentage rate (APR) and is multiplied by the average daily balance and number of days in the billing period.
Studies have shown that about 35% of Americans are late on bill payments. Armed with this knowledge, credit card companies can build a secure source of income by charging late fees. If you’ve ever been slapped with a late fee on a credit card, you know they can be pretty hefty. Plus, the longer you wait to pay, the higher your payment goes up with interest rates. So it makes sense that a credit card company could make money this way.
Interest rates may be the money maker for credit card companies, but there are still ways to lower your credit card’s APR. Credit companies want to offer good rewards programs so that more people will sign up for their cards — after all, one-third of 1,000 cardholders is a much bigger number than one-third of 100 cardholders. All that you have to do to avoid the negatives attached to your card is stay out of that one third.
Keep up on your payments by budgeting responsibly and you can be one of the two in three people who gets to take advantage of all the rewards of a great credit card deal with none of the downsides.
Merchant Transaction Fees
When credit card companies charge merchant fees, they can make money without asking their cardholders for a single penny. Have you ever been to a store that only accepts debit cards, checks, or cash? If you have, you’ve probably wondered why they don’t accept credit cards. After all, credit cards are so ubiquitous, don’t they lose some business by turning away customers who want to pay with their credit card?
You’re probably right. These businesses do lose some business, but they’ve crunched the numbers for their specific dealings and found out that they can save more money by not accepting credit cards. This works because credit card companies will ask for fees from businesses that want to work with them.
For example, say you have a lemonade stand. However, a lot of your potential customers don’t carry cash and they’re not comfortable giving you a debit card. If you were to accept credit card payments, then you could have a lot more customers buying your lemonade.
The credit card company knows this, and they need to make money themselves, so they make a deal with you. They’ll run credit card transactions at your lemonade stand, thereby increasing the number of customers you can serve, and you’ll pay them for that privilege. For your lemonade stand — and many other businesses — this is a win-win.
Things can get a little complicated here for businesses. Many credit card companies will either want to charge you, as the lemonade stand owner, a fee per each transaction or a flat fee that will let your customers use that card however many times they want. Your lemonade stand is pretty small, so you just want to pay a small percentage of each transaction. However, if you start selling a lot more lemonade, you might get a better deal by negotiating a flat fee with that credit card provider.
Here’s what’s so great about credit card companies making money this way: they’re going to offer good deals so that they can get more people to use their cards and it costs you literally nothing to gain these great rewards.
When it comes to your lemonade stand, if there are two credit card companies vying for your business and you only want to work with one, you’re going to choose the one with more cardholders under its wing. The company with the most cardholders is usually going to be the one that offers the best rewards programs.
Cardholder Fees
If you’ve ever had a credit card, this one won’t catch you by surprise. Credit card companies will often charge fees to their cardholders. These may include annual fees, cash advance fees, balance transfer fees, and late fees. Many credit card fees are unavoidable, but that shouldn’t stop you from trying.
If you encounter a fee that you don’t think you should have to pay, call up your credit card company and let them know. Remind them that they rely on your patronage to boost the strength of their brand. Building good credit will also help you strengthen your negotiating position, as you are a reliable borrower.
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