How Banks Make Money With Credit Cards?

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Introduction

From the last couple of years, the use of credit card has become popular and the users multiplied manifold. Why users manage their expenses using credit cards is obvious. It is due because of the large number of benefits offered by the credit card companies. Users get free access to the airport lounge, discounted travel tickets and discounted restaurant bills. Apart from this, you earn reward points and cash back on every single dollar you spend using the credit card. Have you ever wondered how credit card companies earn money even after providing an ample number of services? There are certain ways in which credit card companies earn money.

Annual Fees

The day you purchase a credit card, you are bound to pay annual fees of the credit card irrespective of the fact you use the credit card or not. Different companies offer different annual fees depending upon the credit limit, interest rate, and period of repayment. Charging annual fees is one way in which the credit card companies meet with their expenses. Never judge a credit card based on the annual fees. Sometimes credit cards with zero annual fees usually have a higher APR. Read all the terms and conditions mentioned by the credit card companies in order to ensure the terms are favorable for use.

Interest Rate

Credit card companies charge an interest rate on the net purchase made by the user. This interest rate varies within and is different from company to company. The credit history and credit score of the user affect the interest rate charged by the company. The range of the interest rate varies from 14 percent to 20 percent in a year. The annual interest rate or APR charged by the credit card companies earns them enough money. The income through interest rate charged annually is so high that even a reduction of one to two percent saves enough money to the card users.

Most of the users are in a fix about the concept of the annual interest rate. Credit card companies charge an interest rate on the outstanding bills only if the user pays the minimum balance and does not pay the full balance. Balance is carried from month to month and interest is charged on the outstanding balance. However, the numbers of defaulters who pay only the partial bills and carry the balance from month to month are large in number.

Balance Transfer Fees

Companies offer a special feature of a balance transfer to the users. Through balance transfer, an option the user can pay the outstanding bills of the credit cards using another credit card. Initially, the balance transfer feature costs zero interest rate to the users in order to form them a habit. Once the user becomes habitual and the free period of initial months is over, companies began to charge an interest rate on the balance transfer. Earning through balance transfer is sufficient and sure shot. The percentage of the customers using the balance transfer option is sufficiently high.

Merchant Fees

Various merchants and business owners use the services by the financial institutions in order to accept payments through credit cards. Earlier the magnetic strip cards provided by the banks when swiped at the POS machines used to copy the account details, followed by the signature or pin generation by the user in order to complete the payment. The EMV chip cards, meant for payment of the Euro, Master card, and Visa, later replaced magnetic strip cards. These cards are safer and difficult to clone or hack by the predators.

In the latest technological developments, contact-free wave credit cards replaced the EMV chips. The user needs to flash the credit card before the scanner and the payment will be processed without any contact. In EMV chip cards, the user needed to insert the credit card in the POS machine in order to generate a message. The credit card company will generate a unique transaction number for every transaction and will authenticate the payment. Apart from these various software services by the credit card companies make the payment process much easier and secure.

Not all these services by the credit card companies are free of cost. Usually, the merchant needs to pay annual fees to the credit card companies in order to use these services. In some cases, the merchant is asked to pay a part of the payment accepted. The fees generally vary from one to two percent. Net financial gain to the credit card companies through this source is sufficiently high and accounts enough share among the net profit of the company.

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Penalty Fees

Users need to pay the credit card bill in a certain period. Once the user default the deadlines company impose penalty fees. A large number of credit card users default the payments and contribute to the net earnings of the credit card issuer or company by paying the penalty fees. This income holds enough shares in the net income of the credit card company. Companies are nowhere prone to fraud risk by the user as they hold the signed documents by the user. This ensures fixed income to the card issuers.

Conclusion

Everyone knows the benefits and limitations of using credit cards. So many people save enough using the credit cards and enjoy the ample number of benefits of owning a credit card. Most of the people are in dilemma about the income source of the credit card companies. They are eager to know the ways in which banks make money. The banks’ reserved so many income sources either in the form of annual fees, interest rate or merchant fees.

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