You probably already know the names of the big credit card companies. The largest five in 2022 are Visa, Mastercard, Citibank, Chase, and American Express. Visa alone has over 300 million cardholders, which is close to the population of the United States. How do these massive companies make money?
There are three main ways that credit card companies make money:
- Annual fees charged to cardholders
- Interest payments on credit card debt
- Interchange fees on transactions
What are annual fees?
A credit card annual fee is exactly what it sounds like: a fee that you have to pay just to have permission to use the credit card. The size of this annual fee can vary by card, ranging from no fee cards to over $500 per year. According to the Consumer Financial Protection Bureau, the average annual fee in 2020 was $94. All of the money from annual fees goes directly to the credit card company regardless of whether you actually use the card or not.
What are interest rates on credit card debt?
As we have discussed, carrying a balance on a credit card is taking on debt. This debt is what you owe the credit card company because you spent their money and have not paid it all back. The interest on this debt is profit for the credit card company.
Different cards will have different interest rates. These rates are known as “APR”, or annual percentage rates, because they are expressed in annual terms. However, that does not mean that interest is only charged once per year. Credit card debt is compounded daily so every day that a balance is carried means you owe more money to the credit card company.
This means that credit card companies make money when you don’t pay off your debt in full. The best thing to do, where possible, is to only spend money on a credit card that you can afford to pay off immediately.
What are interchange fees?
An interchange fee is also known as a merchant fee, which is what a store has to pay when a customer uses a credit card. This fee can range between 1% and 3% and reduces the amount of money that the store gets when a customer pays with a credit card.
That is, if you buy $100 of groceries and pay with a credit card, the grocery store may only receive $98 in its bank account. The credit card company will get the other $2. This means that the credit card company makes money when you spend using their card, regardless of whether you pay on time.
Why do interchange fees matter? After all, you never see them, so why should you know about them? Stores feel interchange fees every time people use credit cards, so most increase prices to account for these fees. Therefore, if credit card companies increase their fees, you can expect stores will eventually follow suit and raise prices so their profit margin is not cut down. That means that you, the customer, ends up paying more.
