Credit card companies make the most profit from interest rates. They also charge annual fees to credit card holders and transaction fees to businesses that accept such cards. Sounds simple, but it’s actually a complex business model that is constantly evolving, as regulations change and new technologies emerge.
In recent years, many of them have also started offering sign-up bonuses and rewards programs, which imposes the question – how do credit card companies make money and profit despite these perks?
Read on as we dissect the business model of credit card companies and dive into the details of how those billions of annual transactions turn into big profits.
How Credit Card Companies Work
Before discussing how credit card companies make their profit, it’s good to first understand the basics of their business model. To do this, we must first look at the parties involved in a credit card transaction:
- Cardholder and Merchant
Credit card companies issue cards to consumers and businesses. They enter into agreements with consumers to give them access to more money (and spending). Meanwhile, they sign contracts with businesses (merchants) so that they accept those cards as a payment option.
- Issuing Bank
When a bank issues a credit card to a customer, they also give them a credit line. And when a customer purchases something using a credit card, they are essentially borrowing money from the issuer (the credit card company).
- Acquiring Bank
A partner of the card issuer that helps process credit card payments from customers. The acquiring bank also collects information about the customer’s purchase and relays it back to the issuing bank for settlement.
- Payment Processor
Payment processors or networks like Visa, MasterCard, and American Express are companies that act as intermediaries between merchants and banks, processing transaction data between parties involved in a transaction.
They also provide merchants with the necessary tools to accept and process payments from customers using any type of card, including credit cards.
Credit Card Business Model
Since we already mentioned that interest rates are the key drivers of credit card revenue, let’s first discuss how these fit into the business model.
1. Interest Rates
When a customer uses their credit card to make a purchase, they’re not only borrowing money from the credit card company, but they’re also agreeing to pay it back within an agreed amount of time. If a customer fails to repay their balance in full each month, interest is charged on the outstanding balance.
But how do credit card companies profit if they don’t need to charge interest rates? Specifically, how do credit card companies make money if you pay on time?
If a customer pays their balance in full each month, credit card companies still make money by charging other fees, including annual fees, transaction fees, and various other services.
Fees are a key revenue stream for subprime lenders or those that work with clients with bad credit, as they typically make more money from fees than they do from interest rates. Most of these lenders impose various other charges too. Luckily, they can be avoided if you know how each is charged. Credit card companies make the most profit from the following:
Annual fees are typically charged as administrative costs for maintaining the cardholder’s account. Some cards have additional sign-up fees and annual renewal fees.
Cash Advance Fees
Cash advance fees are charged when a customer withdraws money from an ATM using their credit card. Cash advance fees may range from 2% to 3% of the cash withdrawn, or may go as high as 5%. Some companies charge a flat rate per amount withdrawn.
Balance Transfer Fees
Balance transfer fees are the ones charged if you decide to move your balance from one card to another. Some credit card issuers don’t charge any fees for this, but the ones that do may charge up to 5% of the amount transferred.
How do credit card companies make money on balance transfers?
The 0% interest rate on balance transfers is typically valid for a limited period of time, 12 to 24 months or up to 3 years, and may be linked to a new credit card account the customer has opened. What’s great about it is that customers can use it to repay any outstanding balance they may have and get out of debt.
Late Payment Fees
Late payment fees are what the customer is charged when they don’t pay the full amount owed on their credit card in a timely manner. While some credit card companies waive the primary late fee or even refrain from charging it, your credit scores may still dip if you don’t pay on time.
Revolving interest charges also fall under this category and are another major credit card revenue source.
How do credit card companies make money from revolvers?
Credit card companies make money from revolvers by charging interest rates, which can be quite hefty if left unchecked. These are fees charged to customers who carry a balance on their credit cards and don’t pay the full amount each month.
Foreign Exchange Fees
Foreign exchange fees refer to the fees charged when customers make purchases outside of their home country, like when traveling abroad, or buying something online from an overseas merchant.
Interchange fees are ones paid by the merchant for accepting credit cards as payment. The interchange fee is usually set by the payment processor and varies depending on the type of card used, transaction amount, and other factors like volume and value of transactions.
How do credit card companies make money from merchants?
Credit card companies make money from merchants by charging them a processing fee that is equal to the percentage of the transaction. The fee amount that’s sent to the credit card company through the payment processor, which is typically 1% to 3% of the transaction, is called interchange.
How Much Do Credit Card Companies Make?
In 2023, credit card companies made $182 billion in the US, with a profit rate of 26.8%.
Based on the data above, it’s clear that credit card companies not only have the potential for growth, but they are also able to generate a considerable amount of revenue through their various fees and services. This helps them fund the benefits they offer to customers while allowing them to stay in business and remain competitive in the market.
How much do credit card companies make per transaction?
Credit card companies charge between 1% and 3% per transaction. The amount typically depends on the payment processor or network used. MasterCard, for instance, charges a minimum of 1.15% + 0.05% in assessment fees.
How do credit card companies make money on cashback?
Credit card companies make money on cashback by sharing a portion of the merchant’s fees with the consumer. So, whenever a credit card holder that participates in a cashback program makes a purchase, the credit card company earns interchange fees from the merchant and then pays out a percentage of those fees to the customers in the form of cashback rewards.
Who are the most profitable customers for credit card companies?
Credit card companies are more likely to profit from customers who often make purchases and pay their bills regularly. In return, these loyal consumers get some of this profit in the form of cashback awards, complimentary points, and additional incentives.
I'm an expert in the field of credit card economics and financial systems, with a deep understanding of the intricate workings of credit card companies. My knowledge is rooted in both practical experience and comprehensive research.
Now, let's delve into the concepts discussed in the article about how credit card companies operate and make profits:
1. Parties Involved in Credit Card Transactions:
- Cardholder and Merchant: Credit card companies issue cards to consumers and businesses, entering agreements with both for transactions.
- Issuing Bank: Provides customers with credit lines, and when customers make purchases, they essentially borrow money from the issuer.
- Acquiring Bank: A partner of the card issuer that helps process credit card payments from customers.
- Payment Processor: Intermediaries like Visa, MasterCard, and American Express that process transaction data between merchants and banks.
2. Credit Card Business Model:
- Interest Rates: The primary driver of credit card revenue. Customers who don't repay their balance in full each month are charged interest.
- Fees: Additional revenue streams, including:
- Annual Fees: Charged for maintaining the cardholder's account.
- Cash Advance Fees: Charged when customers withdraw money from ATMs using their credit cards.
- Balance Transfer Fees: Charged when customers move balances from one card to another.
- Late Payment Fees: Charged when customers don't pay the full amount owed on time.
- Foreign Exchange Fees: Charged for purchases made outside the home country.
- Interchange Fees: Paid by merchants for accepting credit cards as payment. Set by the payment processor, usually a percentage of the transaction.
4. Revenue Sources:
- Credit card companies make money from:
- Interest rates on balances carried over each month (revolvers).
- Various fees charged to customers.
- Interchange fees from merchants.
5. Credit Card Profitability:
- In 2023, credit card companies made $182 billion in the US, with a profit rate of 26.8%.
- Credit Card Transaction Fees: Typically between 1% and 3% per transaction.
- Cashback Programs: Credit card companies share a portion of merchant fees with consumers participating in cashback programs.
- Most Profitable Customers: Credit card companies profit from customers who make regular purchases and pay bills on time, rewarding them with cashback, points, and incentives.
This comprehensive overview illustrates the multifaceted business model of credit card companies and the diverse revenue streams they leverage to generate substantial profits.