In 2019, U.S. credit card issuers collected almost $180 billion in interest charges and fees. Let’s dive into the key ways that credit card companies make money. This knowledge might help you keep more money in your pocket.
In 2019, U.S. credit card issuers collected almost $180 billion1 in interest charges and fees – their primary source of revenue. To put that into perspective, the size of the economy in the European nation of Hungary totaled nearly $160 billion in 2018, according to the World Bank2.
Every time you put a purchase on a credit card, you’re most likely putting money into the bank accounts of credit card issuers. Issuers of general-purpose cards (as opposed to retail cards) retained a lucrative sliver of the roughly $3.5 trillion in charges and cash advances rung up in 20173, according to the Federal Reserve.
“Although profitability for the large credit card banks has risen and fallen over the years, credit card earnings have almost always been higher than returns on all commercial bank activities,” according to a 2018 Fed report.
Let’s dive into the key ways that credit card companies make money. This knowledge might help you keep more money in your pocket.
See related: How do credit cards work?
Interest typically makes up a huge chunk of revenue for credit card issuers. John Cabell, director of banking and payments intelligence at market research company J.D. Power, explains that credit card issuers reel in this revenue when cardholders push a balance from one month to the next.
This means that if you don’t pay off your entire balance each month, the credit card issuer typically charges interest until you’ve wiped out the remaining balance.
As of July 1, 2020, the average interest rate (known as annual percentage rate, or APR) on new credit card offers stood at 16.04%, according to CreditCards.com data.
“Consumers should know that interest on unpaid balances is a significant source of issuers’ revenue,” Cabell says. “That is important because consumers ultimately control their spending in this area. By knowing their billing … dates and timing purchases and recurring payments carefully, consumers can ensure they are able to pay their balance in full more often and avoid paying interest.”
However, the most recent J.D. Power study of credit card satisfaction shows 54% of credit card holders grasp little to none of the terms for their credit cards. So, if you fall into that group, you might be coughing up more in interest than you could or should be.
Keep in mind that not all credit card APRs are created equal. A card might offer one rate for a purchase, another rate for a balance transfer, yet another rate for a cash advance and a special introductory rate (perhaps 0%) for new purchases or balance transfers. Even just one late payment can trigger a higher interest rate if it’s at least 60 days overdue.
See related: What happens when you miss a credit card payment?
Cash advance fees
When you borrow money using the credit line of your credit card, you typically pay interest if a balance remains on your card from month to month. On top of that, you often pay what’s called a cash advance fee.
U.S. credit card issuers raked in almost $17.3 billion from cash advance fees in 20184, according to R.K. Hammer, a credit card consulting firm.
Interest rates on cash advances tend to be higher than those for purchases and balance transfers. Data compiled in April 2020 by CreditCards.com found that the average APR for cash advances is 24.8%, compared with an average of 19.84% for purchases. A common cash advance fee is 5% of the amount you’re borrowing or a flat $10, whichever is greater.
A cash advance usually comes in the form of:
- An ATM withdrawal.
- A blank paper check sent to you by a credit card issuer that you then can use to cover a medical bill, for example, or pay off higher-interest debt.
Balance transfer fees
The idea behind a balance transfer is simple: Switch all or part of a balance from a higher-interest credit card to a lower-interest credit card in order to save money.
In some cases, though, those transfers come at a cost – the cost of balance transfer fees.
U.S. credit card holders racked up $54 billion in balance transfers in 20185, according to an August 2019 report from the federal Consumer Financial Protection Bureau. The average fee on those balance transfers was 2.8%, the report says.
No matter the percentage, card issuers reap millions and millions of dollars each month from balance transfer fees. And those fees might be stacked on top of a balance transfer interest rate. Fortunately, a 0% APR accompanies some balance transfer offers.
See related: What is a balance transfer and how does it work?
Some credit card issuers assess an annual fee for the privilege of carrying around one of their cards. Oftentimes, those cards supply sign-up bonuses along with perks like access to airport lounges, exclusive discounts at hotels or monthly credits for ride-sharing services. If a savvy cardholder plays the game right, the value of those perks can offset the annual fee, which can exceed $500.
Cabell of J.D. Power said his firm’s research indicates nearly one-fourth of U.S. credit card holders pay annual fees.
In 2018, annual fees averaged roughly $80 per card, according to the Consumer Financial Protection Bureau report5. The bureau noted that this amount has jumped in recent years due to the rise of “richer” rewards cards that charge higher annual fees. The share of rewards cards with annual fees stood at 18% in 2018, the report says.
“Rewards cards typically carry significantly higher annual fees than non-rewards cards. In part, increased demand from cardholders for high-annual-fee rewards cards with high benefits is driving the increased fee revenues for rewards cards,” according to the report.
Miss a payment by the due date? A credit card issuer might hit you with a late fee.
In 2020, the maximum allowed under federal law for a first-time late payment is $29. Another late payment within six months can lead to a fee as high as $40.
Overall, credit card issuers collected $11 billion in late fees in 2018, according to data from R.K. Hammer.
Foreign transaction fees
When you travel to another country, you might be dinged by a foreign transaction fee when you pull out a credit card to pay for a hotel room, a restaurant meal or a souvenir purchase. Close to half of credit cards charge foreign transaction fees, typically up to 3%.
For every purchase made with a credit card, a merchant must pay a small percentage of the purchase amount to process the transaction (around 2% on average). Part of that money goes to the credit card issuer. Some retailers provide a discount if you pay for goods or services with cash to avoid the use of credit cards and, in turn, avoid interchange fees, Cabell of J.D. Power says.
- Banking Dive, “Banks boost borrowers’ card limits without telling them,” January 2020
- World Bank GDP data
- Federal Reserve, Report to the Congress on the Profitability of Credit Card Operations of Depository Institutions, July 2018
- American Banker, “Booming economy means less fee income for credit card issuers,” February 2019.
- Consumer Financial Protection Bureau, The Consumer Credit Market, August 2019