What Are Two Ways Credit Card Companies Make Money?
Uncover the core financial strategies that enable credit card companies to generate their significant income streams.
Credit card companies serve as financial intermediaries, enabling individuals to make purchases on credit and providing a convenient payment method for goods and services. These institutions extend lines of credit, allowing consumers to borrow funds up to a certain limit, which can be repaid over time. Beyond facilitating transactions, credit card companies generate revenue through several distinct mechanisms.
Interest Charges
A primary way credit card companies generate revenue is through interest charges applied to outstanding balances. When a cardholder does not pay their full statement balance by the due date, interest begins to accrue. The cost of borrowing is expressed as an Annual Percentage Rate (APR), the yearly interest rate applied to the balance carried over. This APR can be fixed or variable, often tied to an underlying index like the federal prime rate.
Interest is typically calculated using methods like the average daily balance, assessing interest daily throughout the billing cycle. For most purchases, a grace period is offered, usually 21 to 25 days, during which no interest is charged if the previous statement balance was paid in full by the due date. However, this grace period generally does not apply to cash advances or balance transfers, meaning interest often begins accruing immediately from the transaction date.
Making only the minimum payment on a credit card balance significantly extends the repayment period and increases the total interest paid. Minimum payments are usually calculated as a small percentage of the outstanding balance, commonly between 1% and 3%, or a fixed amount plus fees and interest. A substantial portion of these minimum payments often goes toward covering the accrued interest, leaving a small amount to reduce the principal balance. This practice allows credit card companies to earn more from interest over a prolonged period.
Fees
Credit card companies also collect significant revenue through various fees, categorized into those paid by consumers and those paid by merchants. Consumer-paid fees include annual fees, charged for the privilege of using some cards, often associated with premium benefits or rewards. These fees can range from around $50 to over $500 annually.
Other consumer-paid fees include:
Late payment fees: Assessed when a cardholder fails to make the minimum payment by the due date. Amounts vary by issuer and may increase for repeat late payments.
Balance transfer fees: Charged when moving debt between cards, commonly 3% to 5% of the transferred amount.
Cash advance fees: Incurred when withdrawing cash, usually 3% to 5% of the advance amount or a minimum of $10.
Foreign transaction fees: Typically 1% to 3% of the purchase total, applied to transactions made outside the United States or with international merchants.
Another substantial revenue stream, often less visible to consumers, comes from fees paid by merchants. Every time a customer uses a credit card, the merchant pays a processing fee, which typically ranges from 1.5% to 3.5% of each transaction.
A significant portion of this processing fee is the interchange fee, sometimes called a “swipe fee,” paid by the merchant’s acquiring bank to the cardholder’s issuing bank. These interchange fees generally account for 1% to 3% of the transaction value and are set by payment networks like Visa and Mastercard.
They help cover the issuing bank’s costs for processing transactions, managing fraud risks, and funding customer rewards programs.