How Do Credit Card Companies Make Their Money?

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Credit card companies make money and line their pockets via at least 10 ways (and I am sure there are more) to generate untold billions of dollars per year.

We all have bills to pay and we all shop on a regular basis. How we make payments makes a difference. Most people will use a payment card (credit or debit) or cash. Few of us will, or for that matter, can live a truly cash life. And banks / credit card companies know and like that, because we remain loyal revenue-generating customers.

Credit card companies add significantly to the cost of living and which is considered by some as an unnecessary social cost, especially to the poor and those who do not or are not in a position to use credit cards. This is due to the 2%-4% merchant fees that are imposed on companies who accept credit cards as a mode of payment, which they configure into the prices they charge – and other merchants who then synchronize their prices with those who accept cards.

 

  1. Transaction fees

You often get charged a transaction fee for credit card transactions. I was in a book shop recently and a client wanted to buy something using a credit card. She was told that a transaction fee of 5% would apply at which point she left without buying anything from the shop. This connects in tandem with my next point. Note the prospective client was going to be charged 5%.

 

  1. Merchant fees

Merchants are normally charged a transaction fee of between 2% and 4% for every credit card transaction. This leads to several outcomes, some of which are considered anti-social:

Merchants normally put their prices up to cover for this fee – but do not tell us about it, since they consider it (and calculate it) as part of their operational costs. This means that we actually pay 2% to 4% more for things that we buy at places that accept credit cards. This is a huge cost to bear. The USA’s center for Nutrition Policy and Promotion calculates the average expenditure for a low-cost meal plan for a family of 4 to be $786 worth of food a month.

Do the sums: $786 x 12 = $9,432 per annum. At 2% or 4% means you pay $188 or $377 per year more for food due to merchant fees.

Even if you do not use a credit card to buy your food, you still bear this cost.

  • There are those who say that they use their cards to buy everything, collect whatever benefits they can and then pay off the card in full every month.
  • There are others who say that we should be given a discount of 2-4% when we pay either cash or with our own debit cards (equivalent to cash).

I am in this latter corner, since my wife and I use our credit cards only for such things as flight tickets (or buying books on the internet – the only internet shopping we do).

Credit card companies also offer numerous benefits such as “points / airline miles / present” which are priced into high interest rates thus adding to the social impact of credit cards on society.

  • Nothing in life is free. Someone pays for it.

 

  1. Product branding / Co-branding.

You help with branding the credit card companies’ products to merchants and other people. They colour their cards blue, red, back, gold, platinum and all colours of the rainbow to show the elitist use of some of their products. And compete with each other in terms of benefits as part of their brand.

Further, co-branded cards i.e. cards that are offered by a credit card company which is jointly sponsored by both the bank and a retail merchant can normally be issued cheaper than a normal privately labelled card AND – here is the clincher – it is normally designed to give the issuing bank access to the retailer’s customer base – i.e. YOU.

 

  1. Your information.

Your information is used for advertisement purposes. Regardless of what organizations say about guarding your private information, it does get into the hands of advertisers. They have little boxes on their forms to tick if you do not want to receive advertisement information but how come I get advertisements from wine cellars etcetera? And by the way this is also a huge problem with utility providers. I still get calls not only throughout the day but almost on the bell at midnight – may I ask from where and how they got hold of my home telephone number?

 

  1. Annual fees.

I was recently charged $30 for annual card fees, which I protested and had reversed by letting the person know that I have been a loyal card carrying revenue generator for 28 years. The fee was waived.

  • You should do the same.

 

Credit card interest rates (generally 18-21%) are exorbitant, especially when compared to the interest you get paid when you save your money with a bank (2 – 3%).

The reason the banks give for this anomaly is that credit card debt is unsecured debt and they lose part or all of the debts that people owe when people declare bankruptcy or negotiate a settlement on outstanding debt or in fact become delinquent and the debt is written off.

Well, card companies are often to blame themselves for this predicament. I have been at the receiving end of cards that arrived at my doorstep without even applying for them (especially in some countries) and they often do very sparse vetting – in an attempt to grab market share / to satisfy KPI’s in order to get annual bonuses.

 

  1. Late fees.

This can be an expensive mistake of between $10 and $35 depending on the bank / card company you are dealing with. In a recent class action against a bank in Australia late fees were found to be illegal but the bank challenged the ruling in the Full Federal Court and the ruling was overturned, meaning that it is legal to charge someone $35 for paying late.

Is the cost of the outstanding amount to the bank $35? What would be fair?

  • I believe the late fee should be calculated as the product of the outstanding amount, the number of days outstanding and a certain % interest rate.

 

  1. Cash advance fees.

Cash advance fees are just one of the increasing fees by way of which card companies make money. Over the counter (OTC) this can range from $2.50 to 2% of the transaction amount (whichever is greater).

 

  1. Cash withdrawals at ATM’s

Fees for cash withdrawal from credit cards are comparable to cash over the counter fees and is again just one of the fees by way of which card companies make money. This can again range from $2.50 to 2% of the transaction amount (whichever is greater).

 

  1. Balance transfer fees.

Most credit card companies now offer credit cards (multiple) debts consolidation with them onto one ZERO % card, meaning that you will not pay any interest on the outstanding balance until (a) a specified time has elapsed – normally 1 to 2 years (b) the amount is paid off OR (c) you use the ZERO % card to make a purchase – at which time the normal high (in most cases 18% – 21%) rate kicks in.

  • Be very aware of this third condition. It can all of a sudden become expensive since the interest rate is then calculated on your outstanding balance plus the new purchase.

But in addition to that, the bank normally also charge you a balance transfer fee.

  • Please ask a pertinent question about this if ever you consider transferring your debt to a ZERO % card.

 

In summary

 

Tread carefully with credit cards. You can land in a lot of financial trouble with them – at any age.

Credit cards comes at a social cost to society – all of us indeed whether you have / use one or not since we all pay more for goods at merchants who accept cards. And even those who do not accept cards (are there any left?) synchronize their prices with those who accept cards. This adds a huge social cost to society.

Credit cards will not go away. So you will have to learn with them and their impact to society.

 

 

 

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