Many popular credit cards don’t charge an annual fee, but still allow you to earn rewards. And some of the ones that do have fees also come with various perks, bonuses, and discounts/rebates that in many cases add up to more than the amount of the fee for the card. How is this possible? Credit card companies make money in a number of ways, which we will group into three main categories or revenue streams.
Transaction or “Swipe” Fees
All card-issuing banks make a little bit of money on every purchase you make with the card (usually about 2-4% of the purchase amount). This is called a transaction or swipe fee (also known in credit card industry lingo as interchange), and it’s paid by the merchants you buy things from with your card.
Credit card companies set this fee for each merchant, and it is often inversely related to the size of the merchant. This means that very large merchants with lots of sales volume (e.g. Amazon, Target, Costco) will typically be charged a lower percentage of each purchase, whereas smaller businesses with less volume (e.g. Mom and Pop shops, non-chain coffee shops) will typically be charged a higher percentage. This is because those larger merchants have such high total sales volumes that the credit card companies can make a lot of money from them even if they charge a lower fee on each transaction. Card companies compete with each other to process merchant sales transactions, so offering a lower fee helps them win the business from those larger merchants.
Some very small merchants may opt out of accepting credit cards altogether because they find the transaction fees to be too high. But most merchants do accept at least some credit cards these days, because lots of their customers prefer to pay with credit cards and are in fact likely to spend more money when paying with a card instead of cash.
Interest Charges
In addition to the transaction fees they charge merchants when customers pay with cards, card-issuing banks charge you, their customer, interest on any purchases you make that are not paid in full by the monthly payment date.
Depending on the size of your purchase and the time you take to pay it back, the total interest charged by the time the purchase is paid off can easily exceed the rewards you earned from the purchase. Or to put it more directly: if you don’t pay your credit card balance off in full each month, using a credit card to buy things is actually costing you money.
If left unpaid for longer periods, large purchases can end up costing you hundreds or even thousands of dollars per year in interest. This is why one of the Crush Credit mantras is Never Pay Interest.
The credit card companies know that lots of their customers can’t afford to pay off their full statement amount every month, and that even highly responsible credit card users will occasionally need to carry a balance from time to time. This is why interest charges tend to be one of the major revenue streams for most credit card issuers.
Assorted Other Fees
The final revenue stream that most card issuers take advantage of is a broad one made up of many smaller components: fees. Some fees are obvious and common, like annual fees and late payment fees. But some are less well-known and may not apply to all cards, such as foreign transaction fees, balance transfer fees, and cash advance fees. As their names would suggest, these fees are charged when you make a purchase in a foreign currency, execute an incoming balance transfer, or use your card for a cash advance, respectively.
While fees typically make up the smallest portion of the revenue that card companies make from their credit card portfolios, they are important for customers to keep in mind because they can add up over time and chip away at the value you get from any rewards you earn, especially if you have cards with annual fees that you don’t use very often.
Here’s a quick list of some of the most common fee types to watch out for:
- Annual Fees
- Late Payment Fees
- Returned Payment Fees
- Authorized User Fees
- Foreign Transaction Fees
- Balance Transfer Fees
- Cash Advance Fees
- Over-Limit Fees (less common these days)
Check out our dedicated post on Minimizing Credit Card fees to see which cards tend to have the lowest overall fees and help you decide which ones are a good fit for your spending patterns and preferences.