The credit card industry is a lucrative business. For banks, credit cards are important and reliable money makers. A 2018 Federal Reserve System report said that “although profitability for the large credit card banks has…
The credit card industry is a lucrative business. For banks, credit cards are important and reliable money makers. A 2018 Federal Reserve System report said that “although profitability for the large credit card banks has risen and fallen over the years, credit card earnings have almost always been higher than returns on all commercial bank activities.”
The accounts you choose and the way you handle them are directly related to card issuers’ economic success, though other factors are also at play. “The American credit card system is a big river of money,” says Daniel P. Ray, credit card industry expert and former editor-in-chief at Bankrate. “A lot of people dip a spoon into that river.”
As a cardholder, you can also earn from credit card accounts. When you do, the credit issuers will still come out ahead. They have multiple revenue streams, so their bases are covered whether you manage the accounts well or poorly.
Credit Card Issuer Profit Sources
To understand where the money is coming from, picture a pie divided into two fairly even halves with interchange and enhancement income on one side and cardholder fees on the other. Robert Hammer, CEO of bank card consulting firm R.K. Hammer, says credit card company income consists of the following slices in order from least to most profitable.
Enhancements. A small, yet still significant, method credit card issuers use to make money is by offering additional products, known as enhancements, to their cardholders. Enhancements are typically insurance products, such as policies for disability income or involuntary unemployment, says Hammer.
For example, let’s say you’re worried about being laid off from your job. If you can’t meet your credit card payments, your credit rating will be damaged. As a protective measure, you might spring for the involuntary unemployment insurance policy provided by your credit card issuer, which is designed to cover the minimum payments on your outstanding debt while you’re unemployed. The cost of the plan typically runs 1 percent of your current balance, so if you owe $5,000, the monthly fee would be $50.
Whether such enhancements are worth the outlay for you is debatable. The National Association of Insurance Commissioners urges consumers to read the details of enhancement policies carefully and to weigh the cost against less expensive options. But for the issuer, they’re certainly fruitful.
Penalty fees. If you lose track of your due date or don’t have the funds to make a payment on time, a penalty fee will probably apply, up to $38.
An issuer can count on a certain number of people faltering on payments. According to a 2018 State of Credit report by credit reporting agency Experian, the 90-day-plus delinquency rate was 7.47 percent of balances in the third quarter of 2017. With each late payment, a new penalty fee is charged, and that money goes directly to the issuer’s bottom line.
Annual fees. Yet another source of revenue is the fee a credit card issuer charges a cardholder to maintain the account from one year to the next. The Consumer Financial Protection Bureau Consumer Credit Card Market 2017 report found that, in 2016, about 38 percent of consumers with especially low credit scores paid annual fees and over half of those with high credit scores did.
Credit card companies may use annual fees to lower risk when issuing cards to customers with less than perfect credit, or to offset the cost of rewards and benefits. Whether the fee is used to lower risk or heighten rewards, though, annual fees help the issuer come out ahead.
Cash advance fees. The fees associated with withdrawing cash from your credit line also add to a credit card issuer’s profits.
If you take a cash advance from your credit card account, the issuer will charge you a percentage of the transaction (often 3 to 5 percent with a $5 to $10 minimum). Therefore, if the minimum fee is $10, the most cash you can withdraw without exceeding the minimum may be $200. A larger fee will be assessed when you take out a lot of cash. Assuming a 5 percent fee, an advance of $3,000 would cost you $150 in fees.
Issuers charge a cash advance fee because it bypasses the interchange fee — which is the largest slice of the revenue pie.
Interchange fees. Every time you use your credit card to buy something, the credit card issuer makes money from interchange fees. Interchange fees are the fees credit card issuers charge merchants to process the payment, usually about 2 percent of the transaction amount.
For this reason, big spenders are highly prized by credit card issuers. After all, the more you charge, the more the issuer rakes in. You could be the most responsible cardholder on the planet — never missing a payment or carrying a balance — and the issuer would still reap financial rewards with interchange fees. The only time an issuer won’t make money from interchange is when you don’t use your card at all.
Other fees. While enhancements, penalties, annual fees, cash advance fees and interchange fees make up a large portion of a credit card issuer’s revenue, there are a smattering of other fees a credit issuer can collect. Other fees include those imposed on foreign exchange transactions. If you travel outside the U.S. and use your card at foreign retailer, the issuer may add around 3 percent to the purchase. Carrying a balance on a high-interest-rate card? If you want to shift what you owe to an account with a lower rate, the new issuer will likely charge you a transfer fee of 3 to 5 percent of the transfer.
Interest. Credit cards are revolving debt instruments, meaning you have the option to pay what you owe incrementally. If you choose to send partial payments, the balance that remains will be added to the next month’s bill, and interest will be assessed and added.
Additional findings from the Experian report: 43 percent of cardholders carried a balance each month, and the average credit card debt was $6,354. That put the total revolving debt in the U.S. at a whopping $1.02 trillion.
Since interest ( an average of about 17 to 23 percent) is applied to these balances, it’s no wonder banks can depend on the profitability of credit cards. “A certain segment of people will always overspend with credit cards and get into expensive debt,” says Ray.
Reducing Your Fees and Interest
The good news, says Ray, is that you can eliminate some of the costs associated with credit cards by identifying which costs are under your control, then making financially smart choices.
If you don’t want to pay an annual fee, choose a card without one. Think twice before purchasing credit card enhancements. If you’re paying $50 monthly for unemployment insurance, consider an alternative approach: Deposit the monthly insurance premium amount into a savings account instead. If you avoid unemployment, you’ll have a lump sum of savings.
It’s key to pay credit card bills on time, says Hammer. “Banks make money when a customer is slightly late all the time,” says Hammer. “Don’t be that person. You can beat this game, but you have to pay attention to what you’re doing.” Set up automatic bill pay with your bank to guarantee you’ll always meet the due date.
Avoid cash advances, advises Ray, and only charge when you’re sure to repay the entire bill to avoid paying any interest fees. Monitor your charging activity closely. Once you’ve reached the maximum amount that you can comfortably pay off by the next due date, stop using the card. No debt means no interest fees, no matter how high the rate may be.
If you have a credit card with a rewards program, you can benefit from liberal charging.
The easiest way to make money from a credit card is by using a cash back card, says Ray. With these products, you get a cash rebate from the purchases you make with the card. Charge $5,000 on an account with a 1.5 percent cash back program and you’ll earn $75. Keep the account to a zero balance and it’s pure profit for you, minus any annual fee.
Point-based rewards cards can be financially favorable, even when an annual fee is attached. “There’s a lot of free income you can earn with the better rewards cards,” says Hammer. “It’s about choice, and there’s tons of choice for consumers today.”