How do Credit Cards Make Money? I Found Out the Hard Way

How do credit cards make money

The following is a post from my lovely wife, Mrs. Frugal Rules. Enjoy…

I pulled my new American Express Sky Blue credit card out of my wallet the other day and swiped it through the card reader at Target. I had time to admire my card since my kids were at home with John. (Typically, standing in line at the store is a chaotic and crazy experience that leaves me wishing I were an octopus so that I’d have enough hands to keep my kids out of all the candy and trinkets in the checkout line) The card was thin and clear and had a picture of a jet flying across it. As the checker rang up my items, I imagined myself in that jet, on a trip to my homeland – sunny San Diego. I knew I was earning air mile rewards with this purchase. I also knew that unlike my spending habits ten years ago, I’d be paying this purchase off in a few weeks. This transformation in my buying behavior all came about after I asked myself one day, ‘How do credit cards make money, anyways?’

Who’s Lending Me Money?

To answer this question, I really needed to start with asking another question – namely, ‘Who am I borrowing from?’ Early in our marriage, John and I used credit cards (like my Discover card mainly) to fund a lifestyle that was beyond our means. He’s talked about it here before, but we made short-sighted, impulsive purchase decisions, and we used our credit cards to fund those decisions. Trips to Vegas, dinners out, new tennis shoes, and movie tickets are just some of the things I remember buying. Now, there’s nothing wrong with buying those things, or even using a credit card to do it, but our problem was that we didn’t have the money in our budget to afford all of them. Unfortunately, we didn’t choose to allow reality to temper our purchase decisions and so, on the credit cards they went.

How Do Credit Cards Make Money?

After discovering that the same credit card companies who had been so eager to fund my foolish lifestyle were now not so willing to help me turn over a new leaf and live a frugal lifestyle, I began to look at the cold, hard reality of how credit card companies make money. Credit card companies have a number of ways of making money, which include:

  • Fees (annual fees, over-the-limit fees, late fees, cash-advance fees)
  • Interest on the revolving debt we carry with them
  • A cut of the purchase price from the merchants we make our purchases from (ranges from 1% to 4% per purchase)
  • Commission from selling cardholders’ names to others so more people can hawk their cards and wares at us

Credit card companies make a lot of money. Total revenue for the credit card industry was nearly $155 billion last year. That’s even with the weak economy driving credit card spending down among consumers. In 2010, credit card companies made nearly $164 billion off revenue from credit card accounts. Credit card companies made almost $23 million from fees in 2009. Since the Credit CARD act went into effect a few years ago, that figure has fallen by a stunning $500K. Now, what you may know that I didn’t at that time, is that credit card debt is unsecured debt. That means there is little that credit card companies can legally do to get their money back if a cardholder refuses to pay off charges they’ve made with that company’s money. You don’t get that feeling though, if you stop making your payments.

How do Creditors Get You to Pay?

Our answering machine filled up with messages from scary-sounding people threatening to come to our home, put us in jail and all other manner of threatening actions if we didn’t pay up. It was at that moment that I realized who I had been borrowing money from all along. My credit card company wasn’t a kind, wealthy benefactor looking to fund the lifestyles of strangers. When my purchases turned from foolish Vegas trips to weekly grocery bills, my lender didn’t care. Now I know that credit card companies care about one thing – the health of their own bottom line. They will make money off me and all their cardholders at any cost. I have made a silent vow to myself that if we ever get into such financial straits again that we don’t know how we will pay for groceries, I won’t charge my groceries; I’ll go stand in line at a soup kitchen, with all three of my kids, first.

How Can You Turn Their Strategy On Its Head?

Credit card companies rely on our foolishness to make money. They’re counting on their  cardholders to let self-control and frugal living go by the wayside. They’re hoping we won’t be able to resist advertising ploys (and I work in the advertising industry, writing the taglines designed to get people to make purchases, so I know how effective they can be). They offer rewards designed to entice us to buy, spend, and shop beyond our means. But we can turn credit card companies’ strategy on its head with a little self-control, a budget and a commitment to frugality.

Today, we use rewards to stretch our budget, not bust it. We don’t make purchases that we haven’t already budgeted money for, and we use the rewards creditors are willing to give us to our advantage. Now, when I swipe my American Express card, I’m making money off of my credit card company instead of the other way around, and it all started the day I asked myself the important question – ‘How do credit cards make money?’

I talked today about my experience falling into and getting out of credit card debt and about how the revelation of who was lending to me changed my borrowing behavior forever. What lessons have you learned about credit cards?


Photo courtesy of: Lotus Head

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About the author:

I'm the founder of Frugal Rules, a Dad, husband and veteran of the financial services industry. I'm passionate about helping people learn from my mistakes so that they can enjoy the freedom that comes from living frugally. You can connect via Twitter / Facebook.

53 comments on “How do Credit Cards Make Money? I Found Out the Hard Way

  1. I think a lot of people don’t realize they take a cut from the merchant, and that merchants build in this cost and pass it on to the consumer. That’s why I am SO big on cash back rewards. You get a piece of it back (not all of it) but if you pay in cash or with a debit card you are losing 100% of that built in cost that is being passed along to you.
    DC @ Young Adult Money recently posted..5 Ways to Make Side IncomeMy Profile

  2. Using a credit card is such a streamlined process that it doesn’t feel like your spending money. Then you get your bill and wonder how you could spend so much. Line by line you soon realize you did spend that much. A lot of people pay a portion and leave the rest as a problem for future-them. Unfortunately this is usually the first step in a complicated dance called the credit card shuffle :)
    Mandy @ MoneyMasterMom recently posted..Net Worth is not your Self WorthMy Profile

  3. I once charged a dishwasher to my credit card knowing I didn’t have the cash to pay it. I really hated doing dishes, and somehow justified the purchase in my head. I had it paid off in a few months, and never carried a balance again :)

  4. When my brother went into credit card debt in his teens, YES teens, I learned that credit cards are not to be messed around with lightly. He was kind of a front man to take all the damage while I learned from his mistakes behind the front lines. Not sure why I’m relating this to a battle scene in my head but it helps every time I have to think about using the credit card.
    Veronica @ Pelican on Money recently posted..Watch Out when Buying GoldMy Profile

  5. Oh, credit cards. They were the reason why I got into debt, well at least part of the reason. I was the main reason, but they helped. I now know how to harness the power of credit cards. I only use them when I have the money to pay them off. I enjoy the rewards, since they fund the 529 account that I setup for my soon-to-be-born son. It’s a win-win for me. The credit card companies still make money off of my purchases through swipe fees, so they don’t care. Great post Mrs. Frugal Rules!
    Grayson @ Debt RoundUp recently posted..Choosing A Debt CounselorMy Profile

  6. Great “guest” post Mrs. Frugal Rules! I definitely learned that handling credit cards poorly can quickly lead to disaster and they’re not very flexible when it comes to collecting on past due payments. Over draft fees rack up quickly, and when you’re behind on your payment the interest rates sky rocket and they add as many “fees” to your balance as they possibly can. Luckily for me, I finally got my head on straight and now work the system the best I can and take as much money from the companies as I can get! :)
    Jason @ WorkSaveLive recently posted..Be Wary of Overseas Credit Card Charges When TravelingMy Profile

    • Thanks, Jason! It is so fun to be a part of John’s community and to see how much fun he’s having with the blog. It’s also neat to see him meeting people like you! Hopefully one day our paths will cross in person. In regards to credit card fees, yes you are so right, I remember those awful fees that seemed to come out of nowhere once we fell behind. That was one of the clearest signs to me that I was borrowing money from corporate thugs and should be more discerning with who I choose as a lender in the future. Having learned the hard way, we definitely use credit to our advantage now instead of being taken advantage of by the credit card companies.
      Nicole@Frugal Rules recently posted..Nothing Says “Merry Christmas” Like George MichaelMy Profile

  7. Hi Nicole,
    Great post. I learned a while back from my mate at the Pizza Shop that he gets charged from the credit card company every time that someone swipes their credit card. I had no idea they had to pay and he says they often encourage them to pay cash if they can. Mrs.CBB says at the spa she used to go to and get her pedicure the same thing was told to her. They simply said “cash only” or debit. It doesn’t surprise me the way they make money, why, because they know they can. It’s lucrative and they aren’t going to miss the opportunity. Our credit cards offers rewards points etc but we pay no fees for our cards. We’ve never had credit card debt that we didn’t pay in full but of course all that pretty interest adds to the money pot. Mr.CBB
    Canadian Budget Binder recently posted..Dollar Store Home Pregnancy Tests-Do They Work?My Profile

  8. The aim of credit card companies is to entice consumers into the high-interest debt trap, and ding them with various fees along the way. Card issuers whine about regulation, etc., but the explosion in the number and types of card issuers tells you just how lucrative the business can be.

    Club Thrifty is right–credit cards can be a useful tool, when used responsibly–but, as you discovered, card issuers are doing everything their marketing geniuses can think of to induce cardholders to be irresponsible! It takes a strong constitution to resist…
    Kurt @ Money Counselor recently posted..3 Diamonds and a Dog #13My Profile

    • Right you are Kurt, and I agree, it is our responsibility as individual cardholders to not use the persuasiveness of creditors/lenders as an excuse for irresponsible self-indulgence. I just think especially as a parent, that it is my responsibility to teach my children not only how to be frugal, but how to use credit wisely so they don’t make naive assumptions about who they’re borrowing from or what they’re getting themselves into.
      Nicole@Frugal Rules recently posted..Nothing Says “Merry Christmas” Like George MichaelMy Profile

  9. To make sure to pay on time. My company was great actually. After I put the bills somewhere, and forgot to pay them on time, I called them up to see if they’d waive the interest (which they did). They then offered to set up automatic transfers.I still get paper bills so I can keep an eye on things, but the money goes out automatically – no more late payments!
    Cat recently posted..My stats for the month of November 2012My Profile

  10. Good post :) Both my husband and I use our credit cards for the majority of purchases but pay our cards in full well before the due date. I was once heavily in debt with credit cards and I truly learned my lesson. It also takes a serious shift in mindset to use credit cards responsibly and more so to use them to your advantages such as earning %rebates, miles, free travel insurance etc…and for some people they may be better off not using credit cards until they are in complete control of their spending habits and emotional triggers that would cause a credit card spending binge.
    K.K. @ Living Debt Free Rocks! recently posted..Death Is Inevitable So Plan For ItMy Profile

    • I agree K.K. A paradigm shift is required to move from thinking of plastic as a line of credit to indulge your desires to viewing credit cards as tools to use for your own advantage. The truth is, we need to establish good credit histories to get good mortgages and other things in life. So, we can’t just ignore credit. But as you suggest, for some, it may be better to cut the cards until they can control their spending.
      Nicole@Frugal Rules recently posted..Nothing Says “Merry Christmas” Like George MichaelMy Profile

  11. Great post! I understand credit cards have to make money, but they are down right greedy. In France very few people use credit card, what we call “carte de crédit” is actually a debit card that will overdraw your account if your balance is insufficient. So most “credit cards” charge about $50 per year in fees. I thought it was normal until I moved to the UK and my cards were free. $50 per card adds up quickly, because people don’t do consumer debt, they have to be creative to charge something anyway.
    Pauline recently posted..Spinach and leek pizza: Make your kids and man eat greensMy Profile

  12. It’s insane how much businesses pay every year so their customers can use credit cards. I work for a small family owned business and my boss told me they pay over $100k per year just in transaction fees. That’s just insane.
    Justin@TheFrugalPath recently posted..Lottery is Not a Retirement PlanMy Profile

  13. My business pays about $6K in credit card fees per year and we have a sweet rate through a health care association. I can’t imagine how much places like Walmart or grocery stores pay. That being said, it’s worth 0.5-3% per transaction to get paid immediately. Sending bills after the fact or getting bounced checks costs lots more. From a personal perspective, we just paid off the last of our $30K in stupid credit card debt. What a wonderful feeling, and I will never feel bad about taking rewards points and not paying interest from now on. They’ve made enough money from our stupidity to last a lifetime. Hope to see more posts from you. Excellent job!
    Kim@Eyesonthedollar recently posted..Reasons to Love Your Used CarMy Profile

  14. I heard enough horror stories about this growing up that I didn’t get a card for a very, very long time as an adult. We carry a little bit of debt, which I’m not proud of, but it’s really not that much and we always find a way to pay it down before interest rates start to make the amount we owe become insurmountable. We really need to cut it all together, though.
    femmefrugality recently posted..Upcycle Scarves into HatsMy Profile

  15. Really, if you think about it, credit cards are a brilliant business model for those organizations that offer them. One thing that I really hate about credit cards (and almost always refuse to get a card if they have it) is annual fees. Sometimes, though, the fee is less than the rewards that you can collect which is the exception. Even though credit cards can be very harmful for those who do not use them properly, I still think they can be a great tool for those people who can handle them.
    Daisy @ Money Smart Guides recently posted..The Round Table – November 30, 2012My Profile

  16. I was terrible at paying my cc bill until I figured out that the great deal I just bought came with an extra 19% tagged on to the price (cc interest)!

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