Credit card use is taken for granted in the United States, where the average consumer carries $7,279 in credit card debt across 3.84 accounts,. Unfortunately, as convenient as they are, credit cards can quickly become money pits if you’re not careful with them.
Understanding how credit card companies make money off you can help you significantly reduce their ability to do so. Let’s explore what you should know to protect your finances.
Types of Credit Card Companies
Contrary to what you might expect, many parties get involved each time you swipe your credit card, including three different types of credit card companies. Here’s how each of them works:
- Credit card issuers: These are financial institutions that provide credit lines. They’re the ones you borrow from when using your card and the ones that come after you for failing to pay your debts. Some well-known card issuers include Capital One, Citigroup, and Bank of America.
- Payment processors: To accept card payments from customers, merchants must pay for a payment processor’s services. These companies provide the necessary software and hardware, such as point-of-sale systems. Some popular options include Stax, Stripe, and Clover.
- Credit card networks: These are intermediaries responsible for communicating each transaction’s data and ensuring funds transfer appropriately. The four main networks in the United States are Visa, Mastercard, American Express, and Discover. The latter two also function as card issuers.
Let’s run through a quick example to help you understand how these companies work together to facilitate your purchases. Say you have a Capital One Secured MasterCard and use it to buy a shirt from a merchant.
The merchant would accept your payment through a point-of-sale system that it bought from its payment processor. The terminal would send the transaction details to the merchant’s financial institution, referred to as the acquiring bank or acquirer.
The acquirer would then send the information through the MasterCard network to Capital One, your credit card issuer. Capital One would consider the request’s legitimacy and your available credit, then approve or deny your purchase.
Either way, Capital One would send the answer back through the MasterCard network to the acquiring bank. If Capital One approved the transaction, it would also send the appropriate funds along the same chain, allowing the merchant’s bank to deposit them on their behalf.
The transferred funds would equal your purchase amount minus the merchant discount rate (MDR). The MDR is a combination of transaction fees imposed on the merchant by the issuer, network, and payment processor for accepting credit card payments.
How Credit Card Issuers Make Money
Credit card issuers make most of their money off cardholders, but a significant portion of their income comes from merchants too. The merchants pass those costs on to customers, so you’re paying those too!
Let’s explore the primary revenue streams they collect from both groups.
Interest charges on account balances tend to generate the most money for credit card issuers. In 2022, they collected roughly $173.2 billion from consumer cardholders, with $145.1 billion coming from interest charges.
Cardholders incur interest charges when they fail to pay off their balances by the end of a billing period and carry it over to the next month. Typically, that occurs when people can’t afford to repay what they purchased and settle for making minimum monthly payments.
Unfortunately, that’s one of the most expensive financial mistakes you can make. Credit card interest rates are much higher than most other forms of financing, carrying an average interest rate of 20.09% in 2023.
To show how quickly that adds up, say you put just $2,500 on a credit card with the average rate. Even if you never put more money on the card, you would take nine years and two months to pay off your debt making 2% minimum monthly payments. You’d accrue $2,964 in interest during that time, more than doubling your costs.
Though not as lucrative as interest charges, fees still account for a significant portion of credit card issuer revenues. Of the $173.2 billion they collected from cardholders in 2022, miscellaneous fees accounted for $28.1 billion.
Here are some of the most common ways that credit card issuers bill cardholders:
- Annual fees: Some credit cards charge you yearly fees to retain access to your credit line. These can range from roughly $50 to $500, with some premier cards costing even more.
- Late fees: If you fail to make the minimum payment on your credit card by your due date, card issuers charge you a penalty. These typically range from $25 to $40 per occurrence. Repeated offenses may cause the cost to increase, but regulations prevent them from exceeding a limit pegged to inflation.
- Cash advance fees: Cash advances let you withdraw cash by borrowing against your card. They’re an expensive feature, typically costing 3% to 5% of the advance amount with a minimum of $10 or so. In addition, the advance usually starts accruing interest immediately at an even higher rate than regular credit card debt.
- Balance transfer fees: Some credit cards let you roll over balances from other credit accounts onto the card. That costs about the same as a cash advance, with a 3% to 5% fee subject to certain minimums. However, the balance usually accrues 0% interest for a limited promotional period between six and 18 months.
- Foreign transaction fees: When you use your credit card outside of the United States, your card issuer may charge you a foreign transaction fee. These fees usually range from 1% to 3% of the transaction amount.
Before you sign up for a credit card, make sure you review all of the fees listed in your cardholder agreement. That can help you avoid nasty surprises, such as an immediate annual fee when you expected not to pay one for your first year.
📗 Learn More: Foreign Transaction Fee: What Is It? How Does It Work?
Interchange Transaction Fees
Credit card issuers make most of their money from the interest and fees they charge consumers. However, they also collect a significant portion of their revenues by charging merchants interchange fees. These make up most of the MDR that merchants pay for accepting credit card payments.
The card issuer collects interchange fees, but the card network is responsible for setting the rates. They typically base the cost on multiple factors, including the merchant’s industry and number of transactions per month, the identity of the card issuer, and whether the payment was collected online or in person.
Interchange fees are generally structured as a percentage of the transaction amount plus a flat charge. For example, Visa’s interchange rates for consumer credit cards in the United States range from 1.15% plus $0.05 to 3.15% plus $0.10 per transaction.
How Payment Processors Make Money
Payment processing companies profit exclusively from merchants. However, merchants can sometimes pass their costs on to consumers through convenience charges or price increases. As a result, understanding what processors charge can be beneficial.
Here’s what you should know about how they make money.
Payment processors can bill merchants for everything that goes into accessing their point-of-sale systems. That may include upfront fees for software, hardware, and installation services, plus recurring subscription charges.
These costs vary widely depending on which processor merchants hire and which solutions they use. For example, Shopify offers a physical card reader for $49 and charges a software subscription fee starting at $39 per month.
Square also charges $49 for a simple card reader but has more sophisticated hardware options for sale, with the most expensive costing $799. Meanwhile, its cheapest software subscription plan is free, requiring no monthly payment.
Processor Transaction Fees
In addition to billing merchants for access to their services, payment processors charge them transaction fees. These make up another significant portion of the MDR and work similarly to interchange fees, often costing a percentage of each transaction plus a small flat charge.
However, processor transaction fees are significantly lower than interchange fees. Helcim’s pricing breakdown helps demonstrate this. If a retail store using Helcim were to accept a MasterCard payment, it would incur an interchange fee of 1.65% plus $0.10, while Helcim would charge a 0.30% plus $0.08 processor fee.
How Credit Card Networks Make Money
Like payment processors, credit card networks don’t make money by charging consumers. Instead, they collect their revenues from credit card issuers and acquiring banks, who pass the expenses on to merchants. Here’s how it works.
Credit card networks earn most of their revenues by charging assessment fees to credit card issuers. These are fees based on the dollar value of the transactions completed with cards bearing their brand.
For example, say Chase Bank has issued 10,000 Visa credit cards, and each cardholder averaged $2,000 in purchases, balance transfers, and cash advances over the last month. As a result, the total dollar value of all their transactions combined equaled $20,000,000.
Visa would charge Chase Bank an assessment fee equal to a small percentage of the $20,000,000 of activity for that month. For context, MasterCard generated a whopping $10.2 billion of its $23.6 billion in gross revenue through assessment fees in 2020, despite international transaction volume decreasing by 29% due to COVID-19.
Switched Transaction Fees
Credit card networks also earn a significant portion of their income by charging issuers and acquirers transactional fees for sending funds and information over their networks. These primarily consist of switched fees, which are generated by the following activities:
- Authorization: This refers to the step in the credit card transaction process where the payment request is sent from the acquiring bank to the card issuer for approval.
- Clearing: This refers to the step where the network uses a cardholder’s financial information and transactional details to calculate the net amount of funds that should go to the acquirer and issuer.
- Settlement: This is the final step in the transaction process, during which the issuer distributes the appropriate funds. Most notably, the acquirer should receive the transaction amount minus the MDR.
Credit card networks charge issuers and acquirers a fee each time they complete one of these steps. MasterCard generated $23.6 billion in 2020, and $8.7 billion was due to these transactional fees. The remaining earnings mostly came from products and services unrelated to credit cards, such as data analytics and consulting fees.
How to Pay Credit Card Companies Less Money
Credit cards are powerful tools, but issuers will take every chance they can get to make money off you. And unfortunately, they’re pretty good at it. Here are some of the best ways to keep their grubby fingers out of your wallet:
- Always pay off your statement balance: This is the amount you spent on your card during the previous billing period. You’ll accrue interest charges if you don’t pay it off on time. Only spend what you have in cash to ensure you can afford this amount each month.
- Never settle for making the minimum payment: If unfortunate circumstances or mistakes prevent you from paying off your statement balance, don’t settle for the minimum amount due. Instead, pay off as much as you can afford to minimize your interest charges and time in debt.
- Avoid cash advances and balance transfers: Credit cards are great for making payments securely, earning rewards, and building your credit score, but they’re terrible for everything else. Just because you can execute transactions like cash advances doesn’t mean you should. They’re expensive traps, don’t fall for them.
- Make sure every card’s benefits justify its fees: Annual fees are one of the few charges you’ll pay regardless of how you use your cards. Since they can get pretty expensive (see the Chase Sapphire Reserve’s $550 fee), choose cards with benefits that outweigh their costs – and actually use them.
Credit cards make it easy to spend more money than you have. Due to the recent inflation surge, American credit card debt is piling up faster than ever. In the fourth quarter of 2022, consumer balances increased by $61 billion and hit $986 billion, exceeding the pre-pandemic high.
Don’t get swept up in that rising tide. Build a budget, pay attention to your monthly card balances, and stay disciplined to protect your finances from credit card companies.
📗 Learn More: How to Use Credit Cards Wisely: 11 Rules to Live By