At first glance, it might be easy to assume that credit card companies don’t make a lot of money. After all, they are letting you use their money. How it that profitable? Well, they care a tremendous convenience and they make it easy to buy things before you have the money and pay back at a later date. But understanding how credit cards work can help you understand your own finances.
The thing is, banks and other issuers make a very big profit off of their services, and here’s how…
The Small Card with Huge Potential
Most people don’t pay off their balances every month. That means that the credit card company gets to charge them a fee for running a balance, i.e., using their money. So the advice here is to pay off your balance and avoid the fees.
There is absolutely no such thing as a “no fee” credit card deal. Banks charge fees such as interest/finance charges on running balances, over-the-limit fees when you charge more than you’re allowed to, and late-payment fees when you don’t pay your bill on time. Some banks may also make an annual charge, plus charge a fee to raise your limit, and even using your credit card to withdrawal cash at an ATM can cost money. Check the fine print on the agreement before you sign and make sure you understand the charging structure associated with your particular card
Whenever you make a purchase, the merchant you buy from has to pay a certain percentage of the sale, a set fee, or both. Merchants consider this fee, usually about 2-3%, a business expense but it is of course, yet another way that the financial institutions make a profit from making a line of finance available to you
Credit Card Company Costs
Although these companies make money off of their cards, it also costs them money to offer them. They pay $50-100 for each customer they get. Advertising and other costs associated with acquiring new customers have to be offset via fees and other charges.
Banks also have to pay to let you use their money. The time period from the moment you make a purchase to the moment you repay the issuer is called a “float.” Banks pay interest to their lenders on the money they lend to you. In general they are borrow money from each other at reduced rates that are not reflected in what is charges to the customer. Just a fraction of a percentage change in the rate they borrow money from each other at can create a massive profit surge for them.
Banks take a hit when customers default on their balances – these bad debts are called “charge-offs.” Banks have to make this money back by charging fees to customers who do pay their bills. Banks work all of their costs into the cost of using their cards.
The Bottom Line
If you think about it, it makes sense that different types of credit card customers have different characteristics for a bank; some are more desirable than others. People who pay their bills in full each month (called “transactors”) aren’t that profitable because they don’t pay fees or finance charges - and finance charges equal profits for banks. People who rack up a lot of debt may not be profitable either because of charge-offs. But, people who revolve some debt and pay fees can be highly profitable.