Cardholders across the world use credit cards to make billions of transactions every year for multiple reasons, such as to avoid carrying cash around and to avail themselves of the privilege of not having to pay a huge amount at once. Credit cards have been growing in popularity throughout the globe over the last decade; while among the European countries, the Nordics, Luxembourg, and the United Kingdom are in the lead when it comes to top credit card countries (with the Netherlands following close behind), back in 2017, Canada turned out to be one of top three countries worldwide with credit card ownership among consumers 15 years and up being over 70%.
(Source: Statista.com)
Further, as per statistics from Statista.com, about 58 million credit cards were in use across India in August 2020, and India ranked 11th on the list of countries worldwide with the most credit cards in use. Now, if you are one of these credit card users, you may have wondered how all these card issuers make money, and how they manage to make profits even when they are giving away plenty of cash backs and rewards and offers.
How a particular credit card company makes money is reliant on its role within the payment ecosystem. So before we start to understand how credit card companies earn money, let’s take a look at the many different kinds of credit card companies, and what work they do.
Different Types of Credit Card Companies
Aside from the cardholder and the merchant you send payments to, there are three primary parties involved in a credit card transaction. They are:
The credit card issuers: A credit card stands for a line of credit you get from your bank and later repay. The bank is the credit card issuer lending you the money, as in when you buy something with a credit card, the bank pays the merchant. In most cases, the card issuer is the only credit card company you might have to deal directly with.
The credit card networks: A credit card purchase actually involves quite a lot of communication within a matter of seconds. Firstly, the merchant has to contact your bank to get the transaction approved, and then the bank has to send the requested funds over to the merchant's account. However, all this communication does not take place directly between the merchant and your bank; it happens through a credit card network (such as Visa or Mastercard). Typically, the credit card issuing banks partner up with various credit card networks for every credit card they issue. The credit cards issued only work with merchants that also work with the cards’ network.
The credit card processors: In most cases, these companies are the go-between for the merchants and the credit card networks. Processors provide merchants with the terminals where clients can insert or tap their credit cards, security, bookkeeping mechanisms, and more benefits. However, unlike the credit card issuers or networks, processors don’t vary with specific cards.
How Do Credit Card Companies Make Money?
Now that we know the different types of credit card companies involved in a transaction, we will be seeing how these companies make money.
How do credit card issuers make money from the cardholders?
Of the three kinds of credit card companies mentioned above, only the issuer profits directly from you, the cardholder. There are several ways they do that, namely:
Annual fees: You have to pay this just to keep your card active.
Interest fees: These are charged by the issuer when you carry a balance on your card past the due date. They are charged as a percentage of the balance on your credit card, depending on your card’s APR.
Transaction fees: Aside from regular purchases, some types of credit card transactions charge an extra fee. For example, if you are making a balance transfer, you will need to pay a balance transfer fee; similarly, if you make a purchase internationally via your credit card, you will be charged additional foreign transaction fees.
Penalty fees: Not sticking to the terms of the cardholder agreement you sign will lead to the card issuer charging you a fee. This includes offenses like paying your bill after the due date or spending more than your specific credit limit.
How do credit card companies make money from the merchants?
While credit card issuers can also profit directly from the cardholders, all credit card companies stand to profit from the merchants. Here's how:
Interchange fees: Every time a client uses a credit card, the merchant is charged an interchange fee by the card issuer to handle the transaction.
Assessment fees: This is charged by the credit card networks on every credit card transaction that makes use of their network, and this goes to covering the cost of maintenance for the payment networks.
Processor fees: The credit card processing company a merchant partners with also charges the merchant, based on the contract between them. Usually, a merchant pays a set fee for every transaction that includes the interchange, assessment, and processor fees, which then the processor divides and passes on to the other companies.
Aside from the aforementioned fees, sometimes you also have to pay a ‘convenience fee’. This happens when the merchant fees are passed on to the customer, such as with utility providers like water or electric companies, or when you try to pay your taxes with your credit card.
How to Avoid Paying Unnecessary Credit Card Fees?
You can avoid extra fees by:
#1 Paying your balance in full every month.
#2 Setting up alerts to notify you before payments are due.
#3 Setting aside money for emergencies so you can avoid options like cash advances.
#4 Paying an annual fee only if the rewards you get from your credit card exceed the expenses.
Being a savvy client and doing your research before getting a credit card would help you reap the benefits of a credit card to the utmost. You can apply for a credit card through the Salt website now!
