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How Do Credit Card Companies Make Money?

16 February 2011 by CreditCardsCo™

It can be difficult to comprehend how credit card companies make money from credit card transactions, especially for those consumers who do not keep a running balance on their cards. Credit cards are most often issued by, or offered in conjunction with a bank. The bank takes in money from borrowers and only pays a small sum of interest. They then lend that same money back out via loans and credit card accounts at a much higher rate of interest. This allows them to make a profit. However, there are various other ways for them to increase their profits.

The Step By Step Process

Every credit card transaction follows the same basic step by step process. The first step is for a customer to visit a store and make a purchase using their new credit card. The credit card reader will then contact the bank who has issued that credit card, and instruct them to pay the purchase total into the merchants bank account.

The merchant's bank will take a small percentage fee from the transaction. This fee is split between the issuing bank and the credit card company. The percentage of fee taken will vary depending on the credit card company, the country and the merchant.

Making Money From Fees and Charges

Credit card companies can make money from fees charged to cardholders. The majority of credit card accounts are subject to fees for late payments, missed payments, and going over the agreed credit limit for the account. Some credit card accounts also carry annual fees. In addition, the banks are often charged an annual fee by credit card companies in order to be a part of the Visa or MasterCard network.

Percentages of All Transactions

The issuing bank for a credit card makes a percentage of every purchase made using a credit card. The percentage rate taken can vary depending on various factors such as the credit card company, the country, and the merchant. The issuing bank shares this percentage fee with the credit card issuer. The amount that the issuing bank receives and the amount that goes to the card issuer is a negotiated deal.

Making Money From Card Holders

There are also opportunities for card issuers to make money directly from cardholders, although this is becoming less frequent due to tighter legislations regarding data protection. Credit card companies would previously have earned additional income by selling customer names and addresses to mailing lists or affiliated companies for the purpose of direct mail marketing. They may also sell advertising space on the bills sent to customers each month.

Interest From Revolving Loans

All of these methods of making money are in addition to the money which is earned from interest applied to accounts carrying a running balance. This is known as interest from a revolving loan. The issuing bank is taking in money from customers and paying them a small rate of interest in their savings.

This money is then paid out via credit cards to cover purchases made on the credit cards. This is effectively lending the money back to customers. The issuing bank charges a higher rate of interest on these borrowings if the purchases are not paid off in full by the customer each month.

Extra Earnings Cover Unpaid Debts

Credit cards are a form of unsecured lending. So if a credit card customer chooses not to, or becomes unable to pay their debt, there is very little that a credit card issuers can do to recover unpaid debts. It can often more expensive to try to collect unpaid debts, than it is to write them off. For this reason card issuers have ensured that even if the debt is never repayed, they will earn money from other sources while the account is active.

Final Word

In conclusion, while it seems as though credit card companies only make money from interest charged on running account balances and fees, they can also make money in various other ways. These include charges made to banks for allowing them to be part of their network, percentages of all purchase made on the card and through selling cardholder information. While consumers can avoid interest charges by paying their accounts off in full each month, credit card companies will still make a profit using a variety of other methods.

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