Newsflash: Credit card companies aren’t giving you bonus points because they love you. They’re doing it so you use their card and they make money.
In this article I’ll explain how creditors profit from you and from the places you shop. If you know how the system works, then you’ll be better able to choose—and use—credit wisely in the future.
What’s Ahead:
Fees from you
Interest
The most obvious way your credit card company makes money is interest charges. If you don’t pay your balance in full each month, you get charged interest, and that’s money in their pocket.
Think about this: The average US household that has debt has more than $15,000 in credit card debt. Meanwhile, the average APR on a credit card is now more than 16 percent.
Using these averages, you’d be paying $1,386 in interest alone if you paid off the debt within a year. If you took two years to pay it off, you’d be paying $2,735 in interest. The longer you carry your debt, the more interest you’ll pay.
Now think about how many customers each credit card company has. In addition, about 34 percent of us are carrying a balance month to month. In fact, we’re paying over $6,000 per year in just interest, on average.
Late fees
This one is pretty self-explanatory. If you make a late payment on your credit card, you’ll get charged. Thankfully, the Credit CARD Act of 2009 helped this a bit, limiting the fee for a first-time late payment to $27. (It used to be $39.)
This also ties into interest fees. Some credit card companies will raise your interest rate after only one late payment. The CARD Act now requires 45 days advance notice of the rate change.Plus, the new rate only applies to new purchases, so you may not be personally impacted if you have another card and just choose not to use the one you were late on.
Annual fees
In 2015, the average annual fee on a credit card was about $58. Typically you only see this with cards that have a solid rewards feature, but you need to do some math to determine if it’s worth it or not.
For example, with a card like the Capital One Venture Rewards card, which offers unlimited 2 percent cash back on all purchases, you’ll pay an annual fee. Thus, you’d have to spend $2,950 per year, or about $246 per month, just to break even on the annual fee. And that’s assuming you’re paying your bill on time and in full every month.
Regardless of whether you use your card enough to warrant paying an annual fee, credit card companies strategically price these fees and offer rewards so they will make a profit no matter what.
Overlimit fees
This used to be a much bigger money-maker for credit card companies than it is now, but they still profit from it. Basically if you go over your credit limit, you’re charged a fee. So for example, if your limit is $2,500 and you buy something for $3,000, you’ll be charged an overlimit fee.
There is one major exception to this, though. The CFPB has a newer guideline in place that says you can only go over your credit limit if you’ve given your creditor permission to allow you to do so.
This means that if you tell your credit card company “no thanks” to being able to go over your limit, your card will be declined instead of approved with a fee.
Cash-advance fees
When you use your credit card at an ATM to take out cash, your credit card company will hit you with a transaction fee (in addition to the one you’ll pay at the ATM). They’ll also place your transaction into a different bucket on your statement, which typically has a much higher interest rate—often over 20 percent.
It’s incredibly costly to take a cash advance and is never a good financial decision. My advice is if you need cash bad enough to charge it on a credit card, seek some professional financial assistance.
Balance transfer fees
A balance transfer is when you move a credit card balance from one card to another. It’s like paying off a credit card with a credit card. Balance transfers can be a fantastic financial move if you do them correctly. If not, you could be paying a lot of money in unnecessary fees.
You may have seen an offer from your credit card company such as “0 percent for 15 months” or something similar. This is their way of bringing your balance to them so they can make money off of you in the future.
I used to work as a credit analyst and I rarely saw people pay their balances off before their promotion ran out. This meant they went back to the regular interest rate, and the company that gave them that “great deal” is now profiting heavily from the interest they’re now paying.
What’s even more immediately profitable for your credit card company, though, is the balance transfer fee. This is a fee that you’re charged the moment you complete the transaction of transferring your balance. Typically fees range anywhere from 3 to 5 percent of the total amount you’re transferring.
So if you’re transferring $10,000 from your Chase card to your Discover card and your fee is 3 percent, you’ll be paying $300 off the bat just do to the transfer. Then you’re put into a promotional rate for whatever period of time the offer is for.
To make this work for you, find offers with low transfer fees and make sure you pay the balance off in full before the promotion expires. I’ve even seen people (who I called rate-surfers) continuously flip the balance from one card to another. Eventually your offers will dry up because your creditors will catch on to you, but it might work for a few years.
Fees from merchants
Interchange
When you buy something with a credit card, you probably assume the merchant gets the full dollar amount. That’s not true. In fact, you may have seen smaller merchants telling you that you have to pay a fee if you want to use a credit card (usually mom and pop shops). This is all because of interchange.
Interchange is the percentage of your total credit card purchase that goes to the credit card issuer and the association that manages the credit card account (i.e. Visa). The credit card issuer will get the majority of this, and it’s usually around 2-3 percent of the total transaction.
Here’s an example. If you buy something for $1,000 on a Chase Visa credit card, you’ll pay $1,000 (not including taxes). The merchant will get that $1,000, but then owe a total of, say, 3 percent to Chase and Visa. So they may only end up with $970 (assuming a 3 percent interchange fee). That additional $30 will be divided between Chase (the card issuer) and Visa (the credit card association that manages it).
Interchange is a big reason you’ll see creditors fighting for advertisements (like on the booklet that gets handed to you at a restaurant) and promotions that encourage you in some way to use your card more often. They’re making a good amount of money every time you swipe your card.
Selling your information
Ever get those privacy policies in the mail every so often? One of the things they’re telling you in those policies is that they have a right to sell your information, unless you explicitly tell them not to.
This is a less commonly known way that credit card companies make their money.
The good news is that your personal information is bundled up with all other customers in one big package. Meaning, your individual data can’t be identified. The companies looking to buy this information, normally businesses that want a better look at consumer buying habits, want to see overall trends—not whether you bought a cheeseburger last night or not.
The bad news is that your creditor is profiting off of your information and usage habits. If you’re uncomfortable with this, I suggest you call your credit card company and ask to not have your information sold. If their policy says that they don’t care what you think, then I’d suggest looking for another card.
Summary
Overall, credit card companies make a boatload of money off of credit card users. Many people think that they’re “not profitable” if they pay their balance in full each month. That’s just not true.
I’m not suggesting that you don’t use credit card at all; in fact I urge you to check out our best credit card reviews. But you must use them wisely.
If you’re going to pay an annual fee, use the card enough to make it worth it. (And don’t buy stuff you don’t need just to justify the fee.)
If you’re going to buy things on credit, pay your balance in full.
If you’re going to do a balance transfer, look for the absolute best deal and pay your balance off before the promotion ends.
By doing these things, you’ll put extra money in your pocket as well as keep it out of the hands of credit card companies looking to make a profit off of you.
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