Credit

How Do Credit Card Companies Make Money?

how do credit card companies make moneyOne day in the late 1960s, Caroll Spinney hailed a taxi in New York to take him to his puppeteering job. When he got into the cab, the driver said to him in a gruff voice, “Where to, Mac?” For the rest of the ride, the driver grumbled and harrumphed about local politics. When he arrived at his job, where his colleague Jim Henson was working on a new curmudgeonly puppet character for Spinney to voice, Spinney knew exactly how he wanted the character to sound, and to this day, Oscar the Grouch is still grumping in that same gruff voice, more than 40 years later.

A lot has changed since then (for one thing, Oscar the Grouch is now green instead of his original orange), but grouchy cab drivers are still a fairly frequent sight. In the early part of this decade, when most cabs had credit card readers but before ridesharing apps became widespread, the subset of cab drivers who can always find something to grump about used to grump about how, when passengers pay with a credit card, the credit card company takes a percentage of the fare.

The fees associated with credit cards can be enough to put almost anyone in a grouchy mood, if you’re not aware of how they work and better yet, how to avoid them as a consumer. These are some of the other ways that credit card companies make money.

Interest Rates Based on Your Credit Score

The higher your credit score, the cushier the credit card you can get, both in terms of high limits and low interest rates. It behooves credit card companies to extend credit to those who they feel can pay off their balances every month. For this reason, the companies tend to offer better interest rates to those with better credit simply because they want to entice those consumers to sign up for their product. If you’ve got a lower credit score you represent more of a risk for the card issuer so they may offer you a higher interest rate to compensate for the additional risk being represented. How credit card interest works is a topic for another post, but for now checkout this post on ReadyForZero.com for a good breakdown.

Credit Card Processing Fees

Credit card processing fees are more or less invisible to consumers, but they are a very real cost to business owners like the crabby cab driver described above. Some companies assess credit card processing fees per transaction, meaning that they take a percentage of the amount the customer paid. Fees are also charged if a customer returns a purchase he or she made with the credit card and gets a refund. Credit card processing fees managed by third party companies are even higher than the processing fees managed by the credit card companies themselves.

Annual Fees

Some credit cards have whats known as an annual fee. This fee simply provides you with access to the credit card in question. These fees can vary greatly from say $95 for the Chase Sapphire Preferred all the way up to $450 for something like the American Express Platinum. They say annual and thats exactly what they mean, so long as you want to continue to keep that card in your wallet you’re going to have to pay that fee. Of course, you’ve got the option of keeping or not keeping that card in your wallet when it comes time to pay the annual fee. Generally speaking, you should not be afraid to cancel a card if you cannot afford the annual fee or you no longer derive value from it. The one major asterisk here is that if its your oldest line of credit then you’re going to hurt your credit score more than you would if it were a newer card.

Fees You Can Avoid

Late fees and fees for going over your credit limit are the most painful type of credit card fees out there, because you can avoid them if you’re able to make at least minimum payments and ultimately pay down your balances entirely. If you let them, they can really create a vicious cycle. The first step to breaking this cycle is to avoid making new purchases on your credit card that you cannot afford to pay off that month. You should do your best to treat your credit card as if it were a debit card or cash, only spend what you can afford to pay off that day. If you follow that advice you will not have to pay much attention to these types of fees which is important; because if you find yourself paying these types of fees chances are the points you’re earning become nearly worthless. A 20% APR is going to wipe out any “profit in points” that you would’ve otherwise earned.  If you accrue these fees because of carelessness or mistakes, getting charged one late fee should be enough to reform your habits, but if you get charged late fees because of actual financial hardship, they can be a nightmare.

Upsells

Have you ever noticed that your paper credit card statement often comes with coupons for services like insurance and discount club memberships? If you buy any of these services, the credit card company gets a finder’s fee.

 

All in all there are a lot of ways that credit card companies can make money. For some, the thought of these various fees scares them into not getting a credit card at all. However, if you’re responsible with your credit, and you make it a point to pay off your balance in full each month then you’ll have nothing to worry about. Paying your balance in full each month means that you can take full advantage of all the benefits that come along with the premium credit card products that we discuss on this site everyday.

 

Have questions? Feel free to reach out, id love to help!

 

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