Visualised: How Credit Card Companies Make Money

Simplifying payments with swipes and taps, but not without danger!

Credit cards are a form of short-term borrowing that enables you to borrow up to the credit limit. The lender (usually a bank) sets a credit limit. Credit cards can be an easy way to get interest-free loans, valuable rewards, travel perks and shopping benefits. If used correctly, they can also help you build your credit score.
But the costs far outweigh the benefits if you don't pay off your monthly balance. Any interest owed will quickly compound, and credit card companies usually charge very high interest in the first place!
Credit card companies make most of their money from charging interest to cardholders who do not pay off their bills completely and on time. Make sure you’re not one of them!

Repercussions of Not Paying Your Credit Card Bills (Partly Or in Full)

Sometimes people go through a rough patch when they can’t get their finances together. Credit cards are not designed for long-term loans, at least from the cardholder's perspective, given the high interest rates they charge (APR). If you absolutely need to borrow money, consider personal loans (as these typically have lower interest rates).

If, for whatever reason, you really can't afford to pay your credit card bills, suggestion #1 is to act quickly while you may still have time to regain some control over the situation. Swallow some pride and contact your credit card company (or companies) to clarify the issue and devise a plan, as many offer some assistance, including skipping a few payments without penalty or possibly reduced interest rates. In most places, you could also contact a free, nonprofit credit counselling service for more guidance.

We recommend that you use credit cards as a mode of payment only. In other words, use your credit card to purchase things and get rewards and discounts simultaneously. However, pay off your monthly bills in full (and, importantly, on time) so no interest is charged. Paying just the minimum or making late payments are a bad habits to slip into.

Example

Denise, Brandon and Wen Qian are desperate to go on a last-minute holiday, but times are tough right now and they can’t afford to pay for a holiday out of their current account.

So they come up with a plan. They decide to treat themselves to a holiday anyway, using their credit cards, at the cost of $5,000pp.

They arrive back home, greeted by the reality that they now have incurred a debt of $5,000. So, they set about working out how to pay it back…

Denise can afford to spare $150 per month to pay off her $5,000. Her credit card APR is 25%

Brandon can afford to spare $150 per month to pay off his $5,000. His credit card APR is 21%

Wen Qian can afford to spare $250 per month to pay off her $5,000. Her credit card APR is 25%

(All of their credit cards have a minimum monthly payment of $100)

The result:

Denise

It will take Denise 58 months to pay off the $5,000 loan based on paying $150 a month @ 25% APR

Total interest paid = $3,625

Brandon

It will take Brandon 51 months to pay off the $5,000 loan based on paying $150 a month @ 21% APR

Total interest paid = $2,569

Wen Qian

It will take Wen Qian 27 months to pay off the $5,000 loan based on paying $250 a month @ 25% APR

Total interest paid = $1,535

The difference in payback time and total interest between Denise, Brandon and Wen Qian demonstrates just how damaging compound interest is when you don’t get on top of tackling your debt. What’s more, the difference in payback time and total interest between Denise and Brandon emphasises the need to pay attention to the APR offered by credit card providers. That four per cent difference cost Denise $1,056 in interest charges!

This example was just for a $5,000 debt. Imagine the debt was $10,000. At that level, the periodic (monthly) interest rate would be 2.08%. Paying back $150 per month, then, would be 1.5% of the principal, so it wouldn’t even cover the costs of interest, let alone pay back the principal. Yikes. You want to have your assets, not liabilities, going to the moon, ideally! 🚀

⚠️ A Warning About Overspending

An MIT study found that a customer’s willingness to pay could increase up to 100% when they use a credit card compared to using cash. Since using a debit or credit card is so convenient, the customer does not feel the sting of spending more money than cold hard cash. A study published in the Journal of Applied Psychology also found that when presented with a cue to use a credit card, diners would tip an average of 4.3% more. Without going into the details of the psychology involved here, we will simply advise that you consider using cash more frequently, especially to pay for smaller purchases.

How Credit Card Companies Make Money

Interchange Fee - collected by card networks to facilitate credit card transactions. For credit cards, they are set at about 1.81%. Financial companies charge this “swipe fee'' in return for accepting the credit risk and handling charges inherent in credit card transactions.
Assessment Fee - collected from a Referred Merchant for the credit card issuer for a transaction. It ranges from 0.09 to 0.12% of your transaction.
Acquiring Fee - charged by the payment processor or merchant acquirer (or just “acquirer”), the organisation that provides authorization, reporting and settlement. It is usually 1-3% of the overall transaction.

Everything, the interchange fee + assessment fee + acquiring fee, gets paid from the Merchant Discount Rate. This is the difference between what you pay the merchant for your stuff and what the merchant actually receives into her bank account.

The Main Thing to Remember

The customers who make credit card companies their money are those who pay late fees and, especially, interest. Credit card companies make significantly more money from interest charges than they do from interchange fees from their merchants. Basically, these poor, unfortunate victims pay for all the costs of running the business* and more. Don't be one of them!

* These costs include the costs of running the business for all cardholders, including the smart and disciplined ones who pay off their entire balances on time every month and therefore don't pay any interest or late fees at all... hopefully cardholders like you!

HOW CREDIT CARD COMPANIES MAKE MONEY. ✅ COMPLETED

Sources

MoneyFitt (ProConnect Technologies Pte Ltd) is not responsible for any errors or omissions, or for the results obtained from the use of this information and shall also not be liable for any damage or loss of any kind, howsoever caused as a result (direct or indirect) of the use of the app and its features, including but not limited to any damage or loss suffered as a result of reliance on the app. All information is provided “as is”, with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information. The information contained is not intended to be a source of advice or credit analysis with respect to the material presented. Any ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial, tax or legal professional and independently researching and verifying information. We do not provide any financial advice, nor are we licenced to.