Credit Cards have become an inevitable part of our lives. Credit card companies work put in all their blood and sweat to grab the customer base. But have you ever wondered how do credit card companies make money?
Credit card companies sanction enormous amounts of money to their customers. Considering the cashback and offers they provide, it might seem like this is not possible for free. Of course, there is no free lunch. But then where exactly do they get their chunk of money from is what this article talks about. There are a plethora of ways through which credit card companies earn. You might already know some ways such as interest and processing fees.
To understand how do credit card companies make money, you must be aware of their working methodology. So let’s discuss that first…..
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How Credit Card Companies Work?
How do credit card companies make money depends on their operating system. Yes, the credit card industry is divided among issuers and networks. Both the card network and issuers work together to make your payment experience smooth.
Credit card issuers are the ones with whom you directly communicate, submit your application, and get the credit card for an approved amount. Whereas, credit card networks (Visa, Mastercard, American Express, etc.) manage the infrastructure that facilitates the payments as and when a purchase is made using the credit card.
Just like cardholders/customers contact a credit card company for a credit card, merchants too, contact a credit card company for managing the fund transfers. Of course, it is quite plausible that you both approach different companies or banks for this purpose. That’s why the common credit card network facilitates the transaction.
So when you swipe your credit card anywhere, then the networks facilitate the transaction by serving as a link between your and the merchant’s card issuing company.
Try to understand it this way, when you swipe your credit card on the payment counter of a shop, the credit card network (which is of course common for both you and the merchant) will be alerted about the payment transaction. They then alert your card issuer company which will send the payment amount to the card network and they’ll ultimately transfer the amount to the company that the merchant has a tie-up with after cross-verification. This all happens within a fraction of a second.
How Do Credit Card Companies Make Money From Cardholders?
Here are five ways through which credit card companies earn from their cardholders-
1. Annual/Renewal Fee
Credit card companies save their profits out of annual charges and renewal charges. Credit lending companies charge their customers for maintaining their credit accounts, and reward schemes, and to offset the risk (in case of poor credit score and payback history). The annual fees usually depend upon the level or tier of your credit card. Quite obviously if you wish to level up your rewards and other card benefits, your renewal fee will also escalate.
2. Cash Advance Fee
Cash Advance fee is another way how do credit card companies make money. For the times when you use your credit card to dispense money from an ATM, you’ll have to pay your credit card company a fee.
3. Foreign Transaction Fee
You might have made a payment using your credit card overseas. Well, this attracts currency converting charges and processing charges that are clubbed in Foreign Transaction fee.
4. Balance Transfer Fee
Before you get to know how do credit card companies make money from Balance Transfer fees, know that not all credit card companies levy this upon their customers.
Some credit lending companies can ask their clients to pay a certain percentage as the balance transfer fee at the time of transferring the balance of their current credit card to another credit card.
5. Payment Default Fee (Interest Penalty)
Not everyone foots their credit bill on the due date. Some clear off the balance in parts while others make a default on the entire amount. So how do credit card companies make money from such clients?
In reality, such clients become the most alluring source of income for credit card companies as they charge an interest percentage on the defaulted amount. The percentage of such an interest is usually very high. Nonetheless, credit card companies accumulate interest penalties based on your past payback record.
How Do Credit Card Companies Make Money From Merchants?
Here are three ways in which credit card companies earn from merchants-
1. Interchange Fee
Whenever a merchant proceeds to take payment via credit card, Interchange fee is levied upon them.
2. Assessment Fee
As mentioned earlier, credit card networking companies lay out a proper strategy and process the payment. They levy an assessment fee on merchants to facilitate the transactions and credit the amount in the merchant’s account.
3. Payment Processing Fees
The payment Processing fee is the charge levied upon merchants for processing credit transactions. It is either charged along with monthly/yearly fees or sometimes charged separately as an interchange fee, assessment fee, and service fee.
Bright Side Of Using Credit Cards
- Seamless Transactions: Credit cards ease transactions as one can make a purchase even if they don’t have the required money at the very time.
- Cashback & Rewards: Credit card companies reward customers who pay back without any default. These rewards can be cashback, discount coupons, redemption points, lower interest rates, etc.
Downside Of Using Credit Cards
- Data Leak Risk: Since credit cards are electronic cards, a lot of financial information has to be stored online. No doubt that credit card networks and companies maintain advanced and encrypted databases to store such information. However, cyber attackers can hack the information and it can lead to credit card cloning.
- Debt Cycle: In case you can’t pay your credit installments duly on time, high interest will be levied on you, which in turn will increase your debt. This vicious debt cycle will keep on going until you clear your payment.
The scope of the credit card market is impeccably huge. However, the fee and charges can vary from person to person. That’s why it is suggested to only go for credit purchases if you can be sure to arrange for the payment to your credit card company before the due date. Otherwise, in case of default, you’ll not only have to bear high interest rates but your credit score will also suffer.