Credit cards make it easy to spend money, they provide valuable fraud-protection benefits, and they might even reward you with travel or cash perks. While you can rack up debt on cards, some people never pay interest. So how do credit card companies make money, and how can you minimize the fees you pay when you use cards?
Credit card issuers and payment networks earn revenue every time you use your card—whether or not you carry a balance. Learning how the system works can help you understand how you (and businesses you buy from) pay for goods and services.
It’s probably no surprise to hear that credit card companies earn revenue on interest charges. Credit card rates can be notoriously high, and minimum payments hardly make a dent in your loan balance, allowing your debt to linger and generate profits.
Some credit card users pay off their cards every month. As a result, they don’t pay any interest, but those customers are still profitable.
Interest charges are easy to spot, but interchange fees are not as well-understood because you don’t pay them directly. However, business owners that accept credit cards are very familiar with the concept. Also known as “swipe fees,” interchange fees are typically between 1% and 3% of your purchase amount.
This is how credit card companies profit whether or not you carry a balance: Businesses or organizations you buy from have to pay charges to their payment processor, and accepting credit cards can be expensive. Some businesses use credit card surcharges to offset those costs and discourage credit card spending, but most merchants treat the fee as a cost of doing business.
Contrast credit card interchange fees with debit card fees, which are limited under federal law. Debit card swipe fees are often 1% or less, so merchants probably prefer that you use your debit card. American Express processing fees are often (but not always) higher than Visa, MasterCard, and Discover fees.
Some cards charge annual fees, while others have no annual fee. If you pay a fee, it may range from $25 to $500 or more. Cards with higher annual fees usually come with rewards like travel points or cash back.
Like interest charges, you can avoid penalty fees, but it’s easy to slip up when you’re busy or facing financial hardship. For example, if you miss your payment due date, you can expect to pay a late-payment fee. If you charge more than your card’s credit limit, you may have to pay an over-limit fee (although you can opt out of that “feature,” and it’s probably wise to do so).
Balance Transfer Fees
Sometimes, you can save money by moving debt to a new card with a 0% interest promotion. Balance transfer offers often promise 12 months of interest-free (or low-interest) borrowing, but there’s a catch: You may need to pay a balance transfer fee to take advantage of the offer. Those fees are often 3% to 5% of the amount you transfer, and they increase your loan balance.
Minimize Your Costs
If you hate the idea of paying fees to credit card companies, be strategic.
- Pay off your balance: Avoid interest charges. With a credit card grace period, you can typically “borrow” without paying interest for at least 21 days. If you can’t pay off your cards every month, it’s critical to address any mismatch between your income and your spending so things don’t spiral out of control.
- Budget for expenses: Don't take on more debt than you need to. Plan ahead for annual bills such as property tax or insurance premiums, and save a small amount each month. Build an emergency fund so you don’t take on debt when something goes wrong.
- Choose cards with low fees: Select cards with low or no fees. This requires reading card information and disclosures carefully. Fortunately, it’s getting easier to find the information you need. Note any annual fees, and scrutinize balance transfer offers to find out how much you’ll pay—and how much you really save after fees.
- Pay on time: You can dodge late payment fees, and you also avoid penalty interest rates and potential damage to your credit. Automate your payments or set up text and email alerts to notify you of upcoming payment due dates.
- Opt-out of over-limit spending: Don’t pay unnecessary fees. Opting out of this feature, merchants will simply decline your card when you reach your credit limit.
- Evaluate rewards realistically: It takes commitment to capitalize on rewards credit cards. With the highest-fee cards, you may need to manage points and travel in specific ways. If that’s not your game, use cards that provide the essential benefits of credit cards: consumer protection and convenient spending.
- Ask for waivers: If a fee hits your account, contact your card issuer and ask if they will remove the fee. It never hurts to ask.