How do Credit Cards Make Money? I Found Out the Hard Way
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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 experience that leaves me wishing that I’d have enough hands to keep my kids out of all the candy and trinkets in the checkout line and not wondering how credit card companies make money) 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 travel rewards with this purchase that would get us closer to another free trip – here are the top cards to help you earn travel rewards as well.
I also knew that unlike my spending habits ten years ago, I’d be paying this purchase off when the monthly bill arrives.
This transformation in my buying behavior all came about after I asked myself one day, ‘How do credit cards make money, anyways?’ If you’re wondering how credit cards make money, then today’s post is for you.
Who’s Lending Me Money?
To answer this question, I really needed to start with asking myself two questions – namely, ‘Who am I borrowing from?’ and ‘How do credit cards work?‘
Early in our marriage, John and I used credit cards 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 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 cards 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 – 4 percent 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 in 2011. 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 over $20 million from fees in 2009.
Since the Credit CARD act went into effect a few years ago, that figure has fallen by a stunning $500,000. 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 wise spending 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 tag lines designed to get people to make purchases, so I know how effective they can be).
The best credit cards 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 purposeful spending.
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.
I already mentioned travel cards, but not everyone wants travel rewards. If that’s your case, here are some cash back cards that can reap you solid rewards.
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?
John is the founder of Frugal Rules, a dad, husband and veteran of the financial services industry whose writing has been featured in Forbes, CNBC, Yahoo Finance and more.
Passionate about helping people learn from his mistakes, John shares financial tools and tips to help you enjoy the freedom that comes from living frugally. One of his favorite tools is Personal Capital , which he used to plan for retirement and keep track of his finances in less than 15 minutes each month.
Another one of John's passions is helping people save $80 per month by axing their expensive cable subscriptions and replacing them with more affordable ones, like Hulu with Live TV.