There’s no doubt about it – credit card companies are in the business of making money. But you might be wondering: With all the payout they do on rewards programs, how exactly do they remain profitable?
If this question has ever crossed your mind, take a look at the information below. Some of the details might surprise you!
Interest payments are a biggie
One big way that credit card companies make money is probably obvious to you – they collect interest payments on people who don’t pay their balances in full every month.
Consider the following: In April 2014, the average American household carried $15,191 in credit card debt. At the same time, the average credit card interest rate is hovering around 15%.
Let’s say you entered 2014 with a credit card debt level that’s at the national average and you’re using a card that charges the average interest rate. Six months into the year (assuming you’re making minimums and not adding any new debt), you will have paid your credit card issuer about $1,100 in interest. That’s over $1,000 paid just for the privilege to delay paying for your purchases.
Also consider that, in 2012, the National Foundation for Credit Counseling found that 39% of Americans roll credit card charges over from month to month. This amounts to millions of people forking over thousands of dollars in interest payments every year. That’s certainly not chump change!
» MORE: What is a credit card?
Hopefully it’s clear by now that interest payments are a huge money-maker for the credit card industry. But what if you never carry a balance on your credit card? Are issuers losing money on you?
Hardly. Credit card companies also make a tidy profit from fees, which come in many forms. For example:
- Annual fees – These are fees customers pay every year in order to keep their accounts open. Not all credit cards charge this fee, but those that do often have a high rewards rate. Annual fee amounts vary wildly depending on the card, but they can run into the hundreds of dollars for some premium plastic.
- Cash advance fees – Issuers charge these fees when customers take a cash advance from their cards. Most run 2%-5% of the amount of cash borrowed.
- Balance transfer fees – These fees are assessed when you move debt from one card onto another (the fee is charged by the card you’re moving the debt to). Most banks charge 3% of the total balance transferred.
- Late fees – Making late credit card payments is costly. Most credit card companies charge $25 for the first offense and $35 for subsequent late payments.
In all of the examples above, the credit card company is charging a fee to the consumer. But there are also fees that credit card companies charge to merchants, the most lucrative of which is the interchange fee.
These fees are assessed on a per-swipe basis: Every time a customer uses her credit card, the retailer has to pay the issuer between 1% and 3% of the transaction amount. Considering how widely used plastic is these days, it’s safe to say that interchange fees account for a sizeable portion of credit card companies’ profits.
Don’t make a habit of lining card issuers’ pockets
Credit card companies are good at making money, but this doesn’t have to come at the expense of your wallet. Follow the Nerds top tips for getting all the benefits of credit card use without the costs:
- Pay your balance in full every month. This way, you’ll avoid costly interest charges.
- Pay your bill on time so that you won’t have to deal with late fees.
- Cash advances are costly. Consider other options for accessing cash before going the cash-advance route.
- If you need to do a balance transfer, try to get a card that doesn’t charge a balance transfer fee.
- Only carry a card with an annual fee if you’re racking up enough in rewards to offset it.
The takeaway: Credit card companies are savvy when it comes to making money. But you don’t have to be another profit center. Use the Nerds’ tips for keeping your credit card costs to a minimum.
Making money image via Shutterstock