As a longtime credit card user (paying with — and paying off — cards since age 18), I’ve never really identified with the “credit cards are evil” mantra that seems to plague public opinion. I’ve cashed in points for airfare so my wife could get away for the weekend, and redeemed points for gift cards to give to clients. However, because I see so many reader comments detailing bad experiences with credit cards, I decided to do some investigating.
I found that the torch-and-pitchfork mob is often led by people who feel they’ve been sucked into credit card companies’ business models of deception, luring customers into paying high interest rates and late fees. But while interest rates and late fees are key revenue sources for credit card companies, by and large, they’re not exactly predatory practices.
Businesses need to make money. It’s our job as consumers to understand the various incentives and disincentives of the products we use so we can make informed decisions about our own money, and whether a business’s services are worth what we pay for them. Consumers need to understand how these companies operate in order to use their credit cards conscientiously and avoid destructive behavioral spirals.
Let’s explore the facts behind how credit card companies make their money and how you can use this information to make smarter financial choices.
A Credit Card Company’s Top Revenue Streams (and How They Affect You)
1. Merchant Fees
The revenue stream: When consumers pay for something using a credit card, they often assume that the retailer receives the entire payment. However, a small percentage of most credit card purchases (roughly 2% or more) gets gobbled up in credit card interchange fees. The bulk of that goes to the bank that issued the card used (for example, Chase or Capital One), while a portion also goes to the credit card association managing the account, such as Visa or MasterCard. (Those companies also charge their partner banks fees for their services, further adding to their revenue.)
Meanwhile, American Express issues its own cards and operates under a “closed-loop” network, meaning it acts as both the card issuer and the credit card association (as opposed to Visa or Mastercard). AmEx’s chief revenue stream is the fee it charges merchants who accept its cards, which account for a staggering 65% of the company’s revenue.
What this means for you: Interchange fees don’t really impact consumers as much as they do merchants, who receive only $97-$98 of a $100 credit card purchase. But even some very small businesses want to be able to accept credit cards to make it easier for their customers to make a purchase, so they are typically willing to pay credit card companies for their services.
While this may seem like an exploitative tactic, the credit card companies act as intermediaries for all parties involved in the transaction: issuing banks, cardholders, and merchants. They handle the complex behind-the-scenes components, including secure financial transfers and fraud monitoring, which is why they can demand these fees. As a consumer, of course, it means you don’t have to carry around a wad of cash or a checkbook to make purchases at most stores and restaurants.
What you can do about it: If you really want your local coffee shop to receive 100% of your purchase, then pay cash. One thing to keep in mind is that some retailers will add a 2%-3% surcharge on Visa and MasterCard transactions — which comprise 70% of all credit cards — to cover the interchange fees those companies charge. Luckily, merchants are required to disclose any credit card surcharges upfront and detail that extra fee on your receipt.
Keep a watchful eye out for surcharges when you pay with credit. Utility companies or government agencies such as the DMV will often add a surcharge if you use a credit card. I try to avoid using a card anywhere that adds this charge.
2. Consumer Fees
The revenue stream: While merchant fees make up a good portion of credit card companies’ revenue streams, they also collect fees from their cardholders — including annual, cash advance, balance transfer, and late fees.
For instance, let’s say you’d like to move your balance on one card to another with a lower interest rate. Most companies will levy a 3% balance transfer fee on your transaction — so if you want to transfer $5,000, you’ll have to pay $150 upfront.
What this means for you: Consumers who haven’t read the fine print are often shocked to discover the number of fees companies charge. Not only will they drive up your credit card bill, but incurring certain fees, like late fees, will damage your credit score, too. Keep in mind that fees can vary by card and issuer, so just because one company or one card doesn’t charge an annual fee, for example, that doesn’t mean another won’t.
What you can do about it: Make sure to find out whether there’s a fee and how much it is before you apply for a new card. Depending on your credit limit and the rewards program, that expense may outweigh the benefits.
Credit cards often come with a range of useful services such as balance transfer offers and cash advances. These can be incredibly helpful in a financial pinch, but they’re not without their costs. A cash advance might seem like the answer to your short-term money problems, but you could be paying that off for years. Talk to your credit card company about the charges, and look for alternative solutions that won’t cause you stress down the road.
If you plan to use a credit card while traveling overseas, research different companies’ foreign transaction fees. These can seriously increase your travel expenses if you’re not careful, so look for cards with low or no fees on international purchases.
Annual fees aren’t fun to pay, but they aren’t the enemy, either; some of the best rewards credit cards charge annual fees. Personally, I have about six credit cards that I use for specific purchases. When I’m deciding to open any new card, I always ask myself, “Does this offer a good return on investment?” A great rewards card might be worth a high annual fee if you use it enough.
Whatever your credit card situation — whether you pay your balances off each month or can only make the minimums for the time being — don’t ever make payments late. This is a careless consumer mistake that creditors make money off of, because they will charge late fees that can really add up on your total bill. It can also trigger an unwanted increase in your interest rate — which we’ll look at next.
The revenue stream: Interest payments undoubtedly provide credit card companies with handsome revenue — especially off of missed payments. A recent survey of 100 major U.S. credit cards found that consumers who fall two months behind on their credit card payments face an average penalty interest rate of 28.45%.
So let’s say you carry a $6,000 balance on your card charging 11.82% — the average APR. At the 28.42% penalty APR, you would have to pay nearly $1,000 extra in interest per year.
In 2014 alone, American Express made a net interest income of approximately $5.8 billion!
What this means for you: Because just a few missed payments can quickly spiral into serious debt, consumers often mistakenly assume that credit card companies want them to get in too deep. After all, that means more profits for the creditors, right?
In truth, while credit card companies do profit from the interest that accrues on overdue accounts, they don’t design their systems to trick customers. The more spending power cardholders have, the more money these businesses make, whether they carry high-interest balances or not. That’s why they provide cardholders with the options to set up automatic monthly payments and send out reminder notices ahead of their due dates.
What you can do about it: Set your account to send reminder alerts via text or email before your bill is due each month, and always pay your balance in full. And while credit card companies make it easy to pay, they can’t stop you from buying things you don’t need or can’t pay off. So every time you’re about to charge something to your credit card, ask yourself, “Can I pay this off on my next bill?”
If the answer is “no,” wait until you’re in a more comfortable financial position. Even a small purchase can quickly become a burden when you account for the interest over time. And paying the monthly minimums won’t help you once you’ve racked up enough interest on the debt. You also want to avoid maxing out your cards, because carrying high balances lowers your credit score.
Treat your credit cards like the finite amount of cash you carry in your wallet. In doing so, you won’t get sucked into the trap of buying more than you need — or can afford.
4. Sales Commissions
The revenue stream: Some credit card companies sell customers’ data to other businesses — particularly retailers that would like to garner better insights into consumer spending habits. Both American Express and MasterCard have profited off of this tactic. MasterCard sells data by ZIP code, which tells retailers what areas are more likely to make purchases. Then, online advertisers can take this data and create targeted advertisements.
What this means for you: Luckily, the data is anonymous and aggregated, meaning companies can’t single you out. However, many consumers aren’t happy to know that companies are profiting off of their personal information.
What you can do about it: This practice is, thankfully, on the decline. Make sure to read card agreements thoroughly to find out whether a specific company will profit off of your data and whether you can opt out.
The Bottom Line
When used responsibly, credit cards offer numerous benefits. Whether you simply don’t like carrying cash or you’re trying to build credit history, they’re convenient and valuable tools.
But there’s something to be said about their ability to separate you from your money. It’s easy to get carried away with your credit lines and blame credit cards for capitalizing on fees while you’re one late payment away from the poor house.
Credit card companies are out to make money — there’s no doubt about that. But it’s important for consumers to understand how those businesses make money, and where their own responsibilities lie.