The simple act of making a purchase actually lets credit card companies earn money. Here are other ways your card issuer profits from you.
Credit cards are undoubtedly convenient for Singaporeans and stores alike. Just imagine, without credit cards, you’d have to carry a wad of cash (or a checkbook) every time you need to make a purchase.
Credit cards in Singapore don’t charge you anything for owning one, as long as you pay your bills in full and on time. In fact, they even give you rewards, air miles, or cashback for using them. So you’re probably wondering, “How do credit card companies make money?”
Although credit cards come with an annual fee attached, these are easily waived. The next seemingly obvious source of revenue is rollover balances and interest. As of end 2015, Singaporean credit card users collectively owed S$5.2 billion in rollover balances. However, this does not represent a significant source of revenue for the banks, because money owed does not count as money earned.
So how exactly do credit card companies make money? Turns out, credit cards are a lucrative business for the financial institutions that issue them. Here are 4 ways credit cards make money from you.
Credit Card Issuers Earn When You Spend
Credit cards make the most money by charging a fee to merchants who accept your credit card as a payment method. But to understand how this works, let’s first examine what goes on in a credit card transaction.
Let’s say you use the American Express True Cashback Card to pay for your groceries at the supermarket. When your transaction goes through successfully, American Express actually pays the supermarket on your behalf. You’ll then be billed for your groceries by Amex later on.
If you used a Visa or Mastercard card, the same thing happens. However, in this case, the bank that issued you the card pays the merchant.
Visa and Mastercard are known as payment networks. They processed the payment transaction between you and the supermarket, and charge the supermarket a fee for doing so. Visa and Mastercard keep a portion of this fee, and pay the bulk of it to your issuing bank.
American Express, on the other hand, is both a payment network and a card issuer. Hence, it both processes the payment and provides the funds for the transaction.
(This is also why Mastercard and Visa credit cards have bank logos on them, whereas Amex cards do not.)
Now you know why banks and card networks are so eager to get you to spend on their cards. They literally make money each time you swipe. In fact, merchant fees account for 65% of revenue for American Express.
Credit Card Issuers Earn When You Don’t Pay In Full
Credit card companies aren’t trying to get you into debt on purpose while hoisting all sort of nonsense charges and fees onto you. Why go to all that trouble when all they make so much money from merchant fees?
This is why you may be offered an enticingly high credit limit of up to 4 times your salary (never mind that spending that much is usually a bad idea). Coupled with low monthly payments, credit cards lull you into a false sense of wealth, which makes you more willing to spend. In fact, credit card companies start raising limits when they want to stimulate consumer spending.
While credit cards may not have been purposely designed to induce overspending, credit card companies nevertheless benefit when consumers accrue debt.
Because most of us are good, moral and upstanding citizens, we feel obliged to pay whatever interest charges and fees we incur in the course of using our credit cards. (Despite oweing over S$5 billion, only S$319 million was written off in 2016.)
There is also the tacit agreement that as long as we continue to pay, we will be allowed to continue using our credit cards.
Here’s the kicker: because of compounding interest, you pay more interest the longer you take to pay your credit card balance.
For credit card issuers, interest is free money that appears out of thin air every month. You can well imagine that as long as you keep those minimum payments going, your bank would be in no big hurry for you to pay off that S$5,000 bill you racked up in Tokyo last Christmas.
Credit Card Issuers Earn When You Miss Payments
Credit cards come with a truckload of terms and conditions that take effect when you miss a payment. Besides the interest charges, there are penalties imposed when you miss your payments, and fees charged for going over your credit limit.
You’d think that after making money off every transaction we put on our cards, issuers would be nicer about getting us to pay up. But no, credit cards are famously ruthless when it comes to late fees and penalty charges, which can easily add over a hundred dollars.
Some issuers even impose temporary increases in your interest rates, which only come back down when you stop missing payments.
Don’t make a habit of letting late fees stack with your rollover balance. It only makes it harder for your to clear your bill, and you’ll be paying more interest along the way.
Credit Card Issuers Earn When You Ignore Your Rewards
Remember all those bonus rewards points that expired because you forgot about them? You’ve just put money back into your credit card issuer’s pocket.
Credit card reward programmes are funded in part by the merchant fees, which issuers earn when you use your card. In essence, you (and all other credit card users) help to generate the rewards you may later on claim.
This also means that when any rewards points and air miles expire, your bank will no longer need to send the shopping voucher or sound bar as promised to you. This translates to savings for them. In the case of air miles though, expired miles benefit the airlines instead.
The same goes for cash rebates, which are applied immediately. As most rebates require a minimum spend, your purchases are (once again) generating the cashback entitled to you. The caps on the cashback also let banks ensure they can continue to offer rebates.
Enjoy Your Credit Cards Responsibly
There is no doubt that credit cards offer alluring rewards, but you should use your credit cards responsibly to properly enjoy them.
Think about it. Spending beyond your means just to rush for air miles is pointless, when doing so means you won’t have enough money to properly enjoy your trip.
For the best way to enjoy all the perks and benefits offered by credit card companies, always pay off your bill in full and on time.