There’s a reason why credit card companies are always looking for more people to use their services. Issuers advance millions of dollars for purchases made by their customers, and they often collect billions in return. The Federal Reserve showed that as of May 2016, total outstanding credit card debt in the United States was $953.3 billion. Credit cards are a huge source of revenue for the issuers. Here’s a look at how they make their money.
Credit Card Companies Charge Merchants
Credit card companies charge stores approximately 2% to 3% of each credit card purchase. If, for example, you use Visa to pay $100 for a bag of groceries, the store from which you made the purchase receives $98 from Visa, while the remaining $2 goes to the credit card issuer and to Visa. When you consider all the billions of daily transactions made collectively by people who use Visa, the merchant fees, also called interchange fees, are a huge source of revenue for the credit card companies.
Credit Card Companies Charge Late Fees
A significant amount of card users do not pay their bills in full each month. The customer’s unpaid credit card balance starts to incur interest at rates as high as 12% or more, which goes to the credit card company. A 2016 National Bureau of Economic Research (NBER) study published by Hong Ru and Antoinette Schoar suggests that credit card companies may deliberately target people who are less-educated, and, consequently, may lack financial sophistication and make faulty financial decisions. Credit card companies approach such people with offers that start off at attractively low rates but rise rapidly with r late and over-limit fees. More-educated people tend not to use these types of accounts.
Similarly, issuers screen for irrational thinking by using rewards programs. Less-educated people tend to receive credit card advertisements that promote higher rewards than those offered to more-educated individuals. These come accompanied with steeply back-loaded fees. It is no wonder that a 2012 Demos study found that households in which someone had been unemployed for at least two months in the three years before 2012 were 14% more likely to carry card debt than households in which all adult occupants had jobs.
The same study found that families with children younger than 18 were 15% more likely to carry debt than families with no children or with children older than 18. Finally, the study found that respondents with a college degree were 22% less likely to be saddled with debt than those who were only high-school educated. Credit companies know they get more than half of their profits from less-educated customers.
Credit Card Fees
Credit card companies tag on a variety of fees in addition to their late fees. Some companies include annual fees, which customers pay every year to keep their accounts open. These yearly fees depend on the credit card company, with the more premium companies charging fees that can stretch into hundreds of dollars. Another fee, called a balance-transfer cost, is charged when customers transfer debt from one card to another. The card that receives the debt is charged. Most companies extract a 3% fee on the transferred balance. Finally, but not conclusively, credit companies add a 2% to 5% cash-advance fee when customers borrow cash from their credit-card account.