How do banks make money through credit cards? Here are 4 ways

Credit cards are one of the easiest ways to buy your favourite products without paying for them in cash immediately. But what does it mean for banks that provide you credit? How do they benefit by lending money to you? Or do they have to wait till the due date to get their money back?

With the rising number of credit card users every year, it has become a very important revenue source for the bank, and therefore issuing a credit card is as beneficial for the bank as it is for the card user. Major sources of revenue for banks through credit cards include merchant fees, interest amounts, marketing-tie up fees and other forms of charges.

Here are ways in which banks make money through credit cards:

Credit card interest rate

Credit card interest or finance charges are fees banks charge for lending money. They are also known as the annual percentage rate (APR) and are calculated as a percentage of the total borrowed money.

Here’s what it implies for banks and credit card users:

Banks: Finance charges or interest levied on credit cards are a major source of revenue for banks. The interest rate for credit cards ranges between 30 and 48 per cent annually.

Users: The high interest rate makes credit cards one of the costliest forms of borrowing. Interest is charged on a daily basis for the amount that needs to be repaid. Users should check the interest rate with banks and estimate the cost of borrowing before getting a credit card issued.

Merchant Fees on Businesses

A charge levied on businesses to accept credit cards as a mode of payment is known as a merchant fee. Banks charge a fee whenever you make a payment using your credit card and therefore the entire amount of the transaction does not go to the businesses. Merchant fee is shared between banks and credit card processing networks.

Here’s what it implies for banks and credit card users:

Banks: Merchant fees are usually minimal and range between 2-3 percent. However, the volume of credit card transactions is a good source of revenue for the bank.

Users: This fee does not affect credit card users as it is charged to businesses accepting credit card payments.

Marketing Tie-Up Charges

Co-branded credit cards, issued by banks in collaboration with brands or service providers, charge marketing tie-up charges. Such cards offer various perks. By partnering with banks, brands try to reach more customers by offering them various rewards and discounts. A fee is charged for providing offers and rewards.

Here’s what it implies for banks and credit card users:

Banks: Marketing-tie up charges generate revenue for banks.

Users: They should opt for co-branded cards only if they frequently shop from the brand, as the marketing tie-up fee should not cost more than the rewards and perks offered by the bank.

Other credit card fees and charges

Credit cards incur various charges, such as withdrawal fees, annual fees, late payment fees, balance transfer fees, foreign transaction fees etc, for customers.

Withdrawal fees: This fee is charged when you withdraw cash using a credit card. It is usually 2.5 to 3 per cent of the total transaction amount.

Annual fee: It is a fee charged every year to maintain the credit card. It varies from bank to bank.

Balance transfer fee: A fee ranging up to 3 to 5 per cent is charged when you transfer debt from one credit card to another. However, some banks do not levy balance transfer fees or waive them off later.

Foreign transaction fees: Credit card users pay fees on transactions paid in foreign currencies, which range from 1 to 3 per cent.

Late fee: Banks charge a late fee if a credit card user fails to pay the minimum amount by the due date. However, banks offer certain concessions on this fee. It ranges between 14 to 40 per cent.

Here’s what it implies for banks and credit card users:

Banks: They generate revenue through various fees; depending on the nature of the transaction, such fees are levied on all users or some of them.

Users: Such fees act as a cost of borrowing for the credit card user. Before getting a credit card, you should ideally check with the card-issuing bank regarding various charges to avoid unexpected expenses on financial transactions.

Choose a credit card which offers affordable fees and suits your financial needs. To get the best deals on credit cards, you should compare fees charged by different banks and choose the most affordable.

The multiple ways in which banks make money through credit cards should be seen as a fee or cost for the convenience of using a credit card. Users should, however, be rational and compare fees charged by various banks and choose the one that suits their financial needs.