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How Are Credit Card Companies Profitable?

Credit cards can provide both convenience and the opportunity to save money if you're getting back some of the money you spend in rewards when you make a purchase or pay a bill. Using credit cards to improve credit history while maintaining good financial practices is also possible. But have you ever wondered how are credit card companies profitable?

They appear to be the same, but they are in fact completely different. If you've never used a credit card before, here are a few things to keep in mind.

What Is A Credit Card?

For purchases, bill payments, or cash withdrawals, a credit card is a physical card. It is easiest to think of a credit card as a short-term form of borrowing money.

When you open a credit card account, you are given a credit limit by your credit card provider. The credit card company gives you a certain amount of money that you can use to make purchases or pay your debts.

As you use your credit card, the number of available credit decreases. You then repay the credit card provider for the money you borrowed from your credit limit.

What Are The Three C's Of Credit?

When it comes to borrowing money, your credit score is a gauge of how likely you are to repay it on time. In addition to your previous loan repayment history, your current salary is factored into the calculation.

Character— A lender may decide whether you have the honesty and reliability to repay a debt based on your credit history. Consider the following:

Have you previously used credit?

Are you a timely payer of your bills?

What is your current address and how long have you been there?

What is your current job title and how long have you been there?

Capital— If income is unavailable, a lender will want to know if you have valuable assets such as real estate, personal property, investments, or savings with which to repay debt.

Capacity— This relates to your debt repayment ability. An employer who pays enough to support your credit use will be looked at by the lender. The lender may be able to determine this by asking the following questions:

How much do you make now?

How many other loans do you have to pay?

How much money do you currently spend on living expenses?

What are your current liabilities?

What is your total number of dependents?

The Different Ways Credit Card Companies Make Money Off Of Cardholders

One hand handing money while other hand handing off credit card
One hand handing money while other hand handing off credit card

A variety of methods are used by credit card firms to generate revenue from cardholders, including interest, yearly fees, and other costs, such as late payment fees. The following is a breakdown of how each of those fees operates:

Interest. Because you're borrowing money, you'll generally be charged interest. It depends on your creditworthiness and the lender. The annual percentage rate (APR), which combines interest and fees into one rate, will vary depending on the lender. Credit card APRs can be pretty high (15-30%), which is why it is crucial to pay in full each month to avoid hefty fees and penalties.

Annual fees. Annual fees are often charged by credit card issuers on rewards cards as well as cards for people with bad credit. Annual fees can be quite expensive, especially for cards that give top-tier benefits, depending on the card and the card issuer. An annual fee of $695 is charged by American Express for their Platinum Card®, which is a rare instance of such a high annual fee.

Other fees. Several fees fall under this category. If you don't pay your bill on time, your card issuer will charge you a late fee. They may also charge you for cash advances, balance transfers, foreign transaction fees, and over-limit costs. The fees differ by the issuer, but if you handle your card well, you may never have to pay them.

How Credit Card Issuers Profit From Businesses

Try buying something from a store that doesn't accept American Express or Discover? Due to the fees charged by this and other credit card networks, some businesses only take cards from specific networks. Depending on the network, these fees range from 1% to 3%.

Avoiding Credit Card Fees

Cardholders profit heavily from credit card corporations. But don't be put off by that: Smart cardholders may avoid most credit card fees. From interest to incidental fees, you may save many fees by budgeting and planning ahead of time.

First, know your annual fees for all credit cards. Then decide if the annual charge is worthwhile. Do the card's benefits outweigh the fee? After carefully reading your card's agreement and noting any potential benefits, take advantage of everything the card has to offer.

Conclusion

A good card management strategy avoids interest: Just make sure you pay your bills on time. If you must carry a balance from month to month, pay it off as fast as possible on the card with the lowest interest rate.

To prevent extra charges, be informed of what you may be charged for. If you know one card charges foreign transaction fees, use a different card when you travel. Same strategy for all cards. Please read your cardholder agreement and make note of any possible events that could result in charges.

About The Authors

Frazer Pugh

Frazer Pugh - I work in the investment management sector as a professional. Previously, I advised top financial services companies on balance sheet management, portfolio planning, and valuations as a consultant. I am currently pursuing a part-time MBA at Melbourne University, where I am a lecturer in accounting and hedge fund strategies, as well as a mentor/coach in a part-time equity analysis initiative. I have a bachelor's degree in economics, a master's degree in finance, and am a Chartered Accountant. I enjoy instructing and assisting others in achieving their objectives.

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