Where Does the Money for Credit Card Rewards Come From?
Retailers and Consumers Ultimately Pay the Price
Credit card issuers are offering better and better rewards and signup bonuses, and consumers are taking advantage of the increasingly competitive market to earn points, miles, and cash back just for swiping. But have you ever wondered how card companies can afford to offer such great rewards? The answer is not as obvious as you might think.
Purchases on rewards cards reached a whopping 88% of spending on general purpose credit cards in 2016, according to the Consumer Financial Protection Bureau.
Where Does the Money Come From?
Credit card companies pay for rewards with revenue from two main sources: you—the consumer—and the merchants who accept their cards.
You’re likely aware of your contribution. You pay interest whenever you carry a balance on your card and fees whenever your payment is late or you get a cash advance.
But most consumers don’t know about the fees that retailers pay card issuers behind the scenes. These fees, called interchange fees, are set by credit card processing networks like Visa and Mastercard to cover both the risk and cost of processing credit card payments.
There are more than a hundred different interchange rates that can be applied to a credit card transaction depending on the type of business, the type of card being used, the transaction amount, and whether the card is dipped, swiped, or keyed. Interchange rates include a percentage of the transaction amount plus a flat fee.
Interchange is just one type of fee retailers pay to accept credit cards. They also pay fees to the credit card networks and their merchant processing providers.
Rewards credit cards have higher interchange rates than run of the mill cards because the card issuers have to recoup the cost of paying the rewards.
For instance, if you used a Visa Signature Preferred rewards credit card to buy dinner out, the interchange fee would be 2.40% of your bill plus a 10-cent fee. So on a $100 tab, the restaurant would pay $2.50. If you used a non-rewards card, that rate might be 1.54% plus the 10-cent fee—or only $1.64.
Interchange fees generate billions of dollars in revenue, helping to cover the expense of credit card rewards.
Take American Express as an example. The company, which is both a card issuer and a network, collected $6.6 billion in fees from merchants in the second quarter of 2019—75% of all its non-interest revenue. In the same quarter, cardholder rewards cost the company $2.7 billion.
Burdened by interchange fees, merchants have waged a series of legal battles with card networks and issuers since the 1990s, and Visa and MasterCard have made certain compromises. In one of the most recent cases, a class-action settlement for more than $5 billion is pending.
How the Cost Is Passed on to Consumers
Merchants can try to recoup the cost of accepting credit cards, but it’s not clear how often they actually do. In recent years, they’ve won the right to assess a surcharge to customers using a Visa or MasterCard credit card, though some states have banned those surcharges.
In some cases, retailers may raise their prices to compensate for interchange fees, so cash buyers end up subsidizing credit card rewards programs. A 2010 study published by the Federal Reserve Bank of Boston found that the average cash buyer effectively pays $149 to card users each year. Meanwhile, the average card buyer receives $1,133 from cash users.
Avoid Paying for Your Own Rewards
Merchant interchange fees are just one form of credit card company revenue. Rewards are also funded through the interest and fees that issuers receive from cardholders.
Whenever a consumer carries a credit card balance, interest in the form of a finance charge is applied to that balance. About 44 percent of cardholders carry a balance each month, according to the American Bankers Association. Discover alone collected $8.8 billion in credit card interest in 2018.
If you truly want to benefit from your rewards credit card, you shouldn’t carry a balance and you shouldn’t pay any avoidable fees, particularly late fees. If you’re shopping for a new rewards card, look for one without an annual fee, unless you’re sure the rewards you’ll earn will more than offset that cost. (Always check the interest rates and fees on the credit card disclosure charts.)
Dharma Merchant Services. "What is Interchange?," Accessed Sept. 25, 2019.
Visa. "Visa USA Interchange Reimbursement Fees," Page 8. Accessed Sept. 25, 2019.
American Express Co. "Consolidated Statements of Income," Page 9.
360 Payment Solutions. "The 360 Payments Guide to Credit Card Surcharging," Accessed Sept. 25, 2019.
Mastercard. "What Merchant Surcharge Rules Mean to You," Accessed Sept. 25, 2019.
Federal Reserve Bank of Boston. "Public Policy Discussion Papers: Who Gains and Who Loses from Credit Card Payments. Theory and Calibrations," First page. Accessed Sept. 25, 2019.
Discover Financial Services. "2018 Annual Report," Page 24. Accessed Sept. 25, 2019.