The credit card industry is definitely a lucrative one. And that doesn’t come as much of a surprise, considering most of us are walking around with a credit card in our wallets. But how do credit card companies make money?
Credit card companies make the most profit from interest charges and other fees. In fact, In 2022 alone, U.S. credit card companies made $130 billion off of consumers. But if you use credit cards wisely, you can often avoid paying these at all!
It all starts with learning the specifics of how credit card companies make money. We’ll be answering that question in this article, as well as sharing a few tips on how you can save money on credit cards.
Types of credit card companies and how they work
Before we dive into how credit card companies make money, let’s talk quickly about what they are and how they operate.
How a credit card company works depends on what kind of company it is. There are two main types of credit card companies: issuers and networks. Let’s learn about each type:
Credit card issuing bank
A credit card issuer is generally a financial institution that issues your credit card and who you pay your bill to each month. Examples of big credit card issuing banks include Capital One, Chase, and Wells Fargo. Smaller credit card issuers are out there too—for instance, even your local credit union.
Credit card network
A credit card network processes the credit card transactions. Major credit card payment networks include Visa, Mastercard, Discover, and American Express. And in the case of Discover and American Express, the companies act as both the card issuer and card network.
Both of these company types are involved with all the credit card purchases you make. When you use your credit card, you’re borrowing money from the credit card issuer. The card network acts as the middle person to process the transaction.
How do credit card companies make money? 3 ways
Credit card companies make money in more than one way. So what are at least two ways credit card companies make money?
There are actually three main ways when it comes to how credit card companies make money. They include:
1. Interest charges
When you use your credit card, you’re borrowing money from a financial institution. If you don’t pay off your balance in full at the end of the statement period, your balance begins to accrue interest.
Credit card companies make the most profit from interest, particularly when the interest grows and compounds. Remember that $130 billion figure we mentioned in the beginning—the amount credit card companies charged consumers in 2022? Well, $105 billion of that came from interest alone.
Unfortunately, this doesn’t come as much of a surprise. According to Experian, the average credit card balance rose to $5,910 in 2022.
Furthermore, the average annual percentage rate (aka APR, or interest rate) on credit cards has recently reached record levels of over 24%. You can keep tabs on the latest figures through Investopedia.
That means the average American is carrying a relatively high balance, and paying a high APR on it.
2. Card user fees
Beyond interest charges, credit card companies also make money on the fees they charge cardholders. Here are a few of the common fees they charge:
Annual fees
Many credit cards don’t require an annual fee at all. However, companies often charge these on cards that come with significant sign-up bonuses or user perks such as cash-back and miles.
The average credit annual fee is about $94. But keep in mind that high-fee premium cards bring this average up.
Balance transfer fees
A balance transfer is when you transfer the balance of one credit card to another card, usually to get a lower interest rate. When you transfer the money, you often pay a balance transfer fee. These fees often range between about 2-5% of the amount you’re transferring.
Cash advance fees
A cash advance is when you withdraw cash from your credit card account. It’s similar to taking out a loan, but you’re simply borrowing against your credit card balance. In addition to the interest you pay on these advances, many companies also charge a fee.
These costs can quickly mount, since the average cash advance fee is 5% of the amount you withdraw.
Late payment fees
How do credit card companies make money from late payments? Well, when you don’t pay your credit card bill by the due date (or at least the minimum payment), you’ll usually be hit with a late fee. In 2022, the average fee for late payments was roughly $32, and U.S. consumers paid a total of $14.5 billion in late payment fees.
While credit card companies make the most profit from interest by far, late fees take second place on the consumer side of things.
Foreign transaction fees
Foreign transaction fees may be charged on transactions made in a foreign currency or through a foreign bank. This fee is meant to cover the costs associated with currency conversion and processing payments through global networks.
If you’re a frequent traveler, it’s worth looking for a credit card that doesn’t charge foreign transaction fees.
3. Merchant processing fees
In addition to the fees they collect from consumers, credit card companies also collect money from the merchant or retailer who accepts credit cards. These fees, known as interchange fees, cover the cost of processing the transaction. Often, the profits are split between credit card issuers and networks.
In 2022, the nation’s six biggest credit card companies collected a combined $31.9 billion in interchange fees.
Sometimes, small businesses charge an extra fee to use credit cards, and this is why. It costs them more to accept credit cards, so they have to weigh whether they can afford it without passing on the costs.
Expert tip: Always read the fine print for your credit card
When you get a credit card, it can feel easier to just throw away that huge terms and conditions sheet that comes in the envelope. But the last thing you want is to be blindsided by unexpected fees. So take the time to understand the terms you’re agreeing to!
For instance, research what late payment fees and interest charges you may face if you miss a credit card payment. Before you travel, make sure you’re aware of any foreign transaction fees.
If you’re trying to use your credit card to get money at an ATM, understand what cash advance fees you’ll face for the privilege. And if the card is subject to an annual fee, keep track of when it will renew.
Knowledge is power, so knowing the terms of your credit cards will help you maximize the value you receive from them.
How to reduce credit card costs
There’s no doubt that credit card companies make a lot of money from consumers. But there are plenty of ways to reduce the amount you’re paying to credit card companies.
In fact, if you use your credit cards responsibly, none of your money has to go to credit card companies at all.
Pay your balance in full every month
The best way to save money on your credit cards is to pay your balance in full every month. When you do this, you don’t have to worry about paying interest. You’re only paying back the amount you actually borrowed.
As an added bonus, paying off your balance doesn’t just help you save money on interest. It also reduces your credit card utilization, which can boost your credit score.
It’s all about using credit cards wisely.
Pay your bill on time each month
Another way to avoid giving your money to credit card companies is to pay your credit card bill on time each month. Doing so can help you to avoid late fees and maintain good credit.
And if you’re having a difficult time remembering to pay your bill, you can set up an automatic payment, so you never have to worry about it. (Although even if you set up autopay, make sure to review your history periodically to make sure your purchases look right.)
Negotiate your interest rate
Credit card interest rates aren’t set in stone. If you find that a lot of your monthly payment is going toward interest, call your credit card company and negotiate a lower rate.
It won’t always work, but it’s worth a shot. Here’s a script that you can use on your phone call.
Search for cards with no balance transfer fees
If you’re transferring your balance to help avoid paying interest, shop around for a card with no balance transfer fees. Depending on the size of your balance, this could save you a considerable amount of money.
Negotiate your annual fees
If you have a credit card that charges an annual fee, you may be able to negotiate with them to waive or reduce your annual fee. Never hurts to ask!
It’s smart to always weigh the annual fee against the rewards you’re getting from the card. If the fee amounts to more than the value of your annual rewards, it might be best to downgrade the card to a fee-free version, or close it.
Have an emergency fund to avoid cash advances
A cash advance is typically only used in the case of an emergency where you need cash immediately and don’t have another way to get it. And while these situations are often inevitable, having an emergency fund in place in a traditional bank account can help you save money.
Rather than paying a cash advance fee and interest, you can earn interest on your emergency fund while it sits in a savings account, and then it’s there to protect you when you need it.
Ask for a late fee waiver
If you lost track of time and got slammed with your first late fee, don’t despair! Many credit card companies will gladly waive them as a one-time courtesy. It helps if you have a history of on-time payments and a good relationship with the issuing bank.
Check your credit card statement regularly
Many of us have had a situation where we check our credit card statement, only to find something that shouldn’t be there. Sometimes it’s an honest mistake, and the credit card company fixes it, but sometimes it’s a fee that we weren’t expecting.
And in the worst-case scenario, it’s a case of identity theft where someone has used your credit card number. Checking your statement regularly can help ensure you aren’t paying for any fees or purchases that you shouldn’t be.
How do credit card companies make their biggest profits?
Credit card companies make the most profit from the interest charges they levy on cardholders. Even though credit card companies have a variety of revenue streams, this one stands out above the rest.
Thanks to sky-high annual percentage rates, credit card companies can earn a lot of money from users who don’t pay off their balances. But you can hack the system and pay zero interest charges by paying your statement balance in full each month!
Why are credit cards so profitable to banks?
Thanks to the triple-whammy interest stream of interest, consumer fees, and retailer fees, credit cards can be quite profitable and lucrative for an issuing bank. Even when you factor in the credit card rewards they pay as user incentives, the banks still come out ahead in profits.
Do credit card companies make money if you pay in full?
Yes, credit card companies can still make money even if cardholders pay their full balances each month. So how do credit card companies make money if their customers are all financially savvy?
While they won’t earn interest or late payment fees from those who clear their balances on time, credit card companies still have other revenue streams. These include the transaction fees they charge to merchants, annual cardholder fees, balance transfer and foreign transaction fees, etc.
What are at least two ways credit card companies make money?
Credit card companies use various strategies to generate revenue. But when you look only at their main sources, how do credit card companies make money?
The top two ways credit card companies make money are:
- Interest charges
- Merchant fees
This means that the biggest sources of credit card company income are split between consumer and retailer charges.
Now you know how credit card companies make money
Credit card companies make billions of dollars each year, primarily from their customers. Unfortunately, many people don’t realize just how much of their hard-earned money is going to their credit card company.
If you use a credit card, it’s important that you understand the advantages and disadvantages. It’s also important that you plan your finances and budget accordingly so you can pay off your credit card balances as soon as you can.
Luckily, following the tips above can help you to avoid unnecessary interest and fees and keep more of your money for other financial goals.