How do banks make money from credit cards?

Here’s a breakdown of the income which banks receive from the issuance of credit cards.

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Credit cards can be a useful means for consumers to improve their financial situation. They may offer rewards and cashback, provide convenience in place of cash, as well as have greater protection than other payment methods when the item or service being purchased is above £100.

As well as potentially benefiting consumers, however, credit cards also generate a significant income for credit card companies from a diverse range of sources. Here’s where banks and other credit card issuers generate their profit.

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Interest

Perhaps the most obvious way that credit card issuers generate income from credit cards is interest payments made by consumers. This makes up the largest portion of their income, with anyone who carries a balance from month to month paying interest on their debt (unless the credit card has a 0% interest rate due to a balance transfer or introductory rate, for example).

Consumers can avoid interest charges through paying their balance off each month. A useful means of doing so is to set up a direct debit to automatically pay off the amount each month. Alternatively, a simple calendar alert in an electronic diary to clear a balance may also suffice to help cardholders avoid paying interest.

Consumer fees

Credit cards charge consumers a variety of fees, including annual fees, fees for late payment of a balance, charges for withdrawing cash, as well as a non-sterling transaction fee when the card is used abroad.

For many consumers, it is possible to find a credit card that offers relatively low levels of fees. For example, there are a variety of credit cards available that do not charge annual fees, while a wide range of travel cards could cut the cost of spending when abroad.

Consumers may also be able to offset a proportion of the fees they are charged by maximising the benefits available when using a credit card. For example, a rewards or cashback card could help offset an annual fee, although such cards generally have relatively high rates of interest; this makes it even more important to repay them in full each month.

Merchant fees

Credit card issuers also generate income from charging merchant fees. They are generated when a retailer accepts a credit card payment, with the retailer paying a percentage of the value of the sale to the credit card issuer. This is generally around 1.75% and is called an interchange rate.

The credit card network also charges retailers a fee per transaction. Networks include Visa and Mastercard, for example, with them charging around 0.12% per transaction.

The existence of merchant fees can mean that credit card issuers are willing to offer sizeable amounts of cashback and rewards in return for card usage. As such, consumers can receive money or vouchers from rewards points over the long run, simply from using their credit card wherever possible.

Takeaway

Credit cards are a lucrative product for banks and other issuers. For consumers, credit cards can be costly in terms of interest payments and fees. However, by ensuring that balances are paid off in full each month and fees are kept to a minimum by shopping around for the best card given an individual’s personal circumstances, it may be possible to benefit from having a credit card.

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The Motley Fool receives compensation from some advertisers who provide products and services that may be covered by our editorial team. It’s one way we make money. But know that our editorial integrity and transparency matters most and our ratings aren’t influenced by compensation. The statements above are The Motley Fool’s alone and have not been provided or endorsed by bank advertisers. The Motley Fool has recommended shares in Lloyds, Tesco and Barclays.

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