How Do Financial Institutions Make Money From Credit Cards?

Credit Cards

Banks are primarily responsible for issuing credit cards. On the surface, it might look like they are doing you a huge favor by handing over a magic chip that will take care of your unexpected expenditures. However, credit cards are beneficial to financial institutes as well.

But how do financial institutions make money from credit cards? In order to understand this, we have to look into two main terms associated with First Premier credit card use: issuers and networks.

Credit card issuers are either banks or other credit unions that provide credit cards to users. Common examples of credit card issuers are Capital One Bank, Credit One Bank, Citi, Chase, etc. Basically, these are the lenders that will let you borrow money from them in the form of a credit card.

Did You Know? Retail credit cards work a little differently than typical cards. These are issued by the bank in accordance with the retailers whose name it carries. This can be a merchant, gas company, store, brand, etc. They are also known as co-branded cards.

Another important term is credit card networks. These are the companies that have the responsibility to track, process, and complete credit card transactions. You must have heard the names such as Visa, Mastercard, or Discover. These are all credit card networks. Discover is both a credit card issuer and network.

Now that you know how credit card payments and business works, let’s talk about how it is beneficial for the financial institutions that provide cards to customers.

First of all, Credit Cards Are Not For Free!

The impression that you have to submit an initial deposit for secured cards whereas unsecured cards do not need a fund at the start, might make you think that they are free of cost. The truth is no credit card comes without charges, although it might be so minimal that you don’t bother yourself with calculations.

Whether you apply for a secured card or an unsecured one, you will have to pay a fee for opening the account. Later on, there will be monthly maintenance charges, penalty APRs (that we will discuss shortly!), foreign exchange fee, cash advance fee, a fee for an increasing credit limit, a fee for upgrading credit card, and on top of all that, some cards also charge a hefty annual fee.

Here’s a breakdown of some important changes that you need to look into before you apply for a credit card.

Annual Fee: High annual fees are typical of high-end credit cards that offer rewards such as cashback offers or discounts. Some unsecured credit cards also charge a hefty annual fee to those who have a poor credit score.

Balance Transfer Fee: These are the charges that you need to pay when you transfer debt from one account to another. Typically, the balance transfer fees are between 3% to 5%. However, there are issuers that do not charge any transfer fee at all, such as the Chase Ink Preferred Business credit card.

Cash Advance Fee: You have to pay this fee if you use a credit card to withdraw cash at an ATM. Typically, it is between 2% to 5% of the amount that you withdraw. Some issuers also impose a minimum amount that would be charged regardless of the cash advance, such as $5.

Where does this money go? It adds directly to the profit that the bank is making by issuing credit cards!

Now, Let’s Look Into Penalty APRs

We mentioned above that banks also charge penalty APRs. In fact, they make the most out of this type of fee. Penalty APRs are typically the charges you have to pay in the case you are late in clearing monthly dues. Each credit card has a different ongoing APR. It also depends on your creditworthiness. However, the exact APR would be made clear to you once you are accepted for a credit card.

The only way to avoid interest charges is by making timely payments and preferably in full. This is the advice that you will hear an ample amount of times when you are trying to fix a poor credit score.

That is because timely payments let the credit card issuer know that you are responsible for the card’s use and have strong financial stability. It shouldn’t come as a surprise when we say banks love to do business with customers who give them the least amount of trouble!

Lastly, They Make Money From Credit Card Payments

With a trolley full of groceries, you walk to the cashier, take out your card, and swipe it. Now your dues are clear! We all are happy to avoid counting notes and carrying so much money in the wallet as a risk. Credit cards save us the ordeal, phew!

However, the process of making payment via credit card is not as straightforward as it seems. Although you have completely transferred the funds to the retailer, the shop now has to share a portion of it with the credit card issuer as well. This rate can vary but mostly it is around 1.75% of the total bill.

Take-Home Message

Credit card use is not as simple as it looks. You may simply be swiping the card but a lot goes on behind the machine.

The electronic money moves from your hands to the credit card issuer, it is processed by the network, and then finally transferred to the merchant’s bank. While a credit card is convenient for you, it is also a source of income for financial institutes that are involved in issuing it or processing its transactions.

Whether it may be in the form of interest or additional charges such as annual fees or cash advance fees, you play an important role in how credit card companies make money. Although some expenses are unavoidable, you can limit the amount you pay to the bank by avoiding interest charges, making timely payments, and paying bills in full.

Furthermore, you can avoid other types of expenses as well. For example, cash advances will not be necessary if you put money aside as an emergency fund. You can also choose a card without a balance transfer fee to save yourself from paying 3% to 5% additional costs.

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