How Banks Make Money with Credit Cards

When it comes to money, we Indians are cautious by nature. Among millions of credit card users in the country, there are also millions who are of opinion that credit cards are evil. For someone who has been using credit cards for many years and enjoyed several benefits on them, it is quite difficult to identify with the idea of credit cards being bad. The truth is- credit cards won’t harm your finances unless you delay or miss payments.

Banks also need money to function which they earn in the form of fees, charges and interest. It would be wrong to call it a predatory practice. In fact, as consumers, it is our job to understand the incentives and limitations of the product we seek in order to make informed decisions with respect to our own money. When we buy a dress, we check the material and design and then judge whether it is worth the price. So, why not do the same with financial products?

To help you make better decisions related to your credit cards, let us first understand how banks make money on credit cards.

• Fees

Banks charge fees from their credit card users in the form of annual fee, cash advance (withdrawal) fee, balance transfer fee, late payment fee, foreign transactions fee, etc. Some of these fees are levied on everyone irrespective of the usage on the card such as annual fee whereas other charges may be levied only under predefined circumstances.

What this means for you?

If you want something more than just basic perks, you will need a better credit card which mostly entails annual fee which can range anywhere between ₹ 500 to ₹ 10,000. Before you get a card, ask the bank representative about annual fee and any additional charges that the bank may levy towards the maintenance of the card. Choose a card with annual fee that you can afford; the card should also offer benefits that suit your lifestyle. If you have received the credit card under a special zero annual fee offer, you must ask about any hidden terms it might entail.

Apart from the annual fee, there are other useful services which again are not free. For example, a balance transfer can help you save a lot of money which you would otherwise have to pay as interest on the other card that is overdue. Even if the bank charges a minimal fee for it, this service can be quite helpful. However, you should always compare the charges that you would pay by availing the service and the charges that you were paying otherwise in order to make the right choice. Read the credit card terms and conditions thoroughly so that you don’t have to regret later.

• Interest/Finance Charges

Interest is a source of handsome revenue for the banks. This is also the reason why only those who do not pay their bills on time find credit cards to be evil. Credit card is the costliest form of borrowing with interest rate ranging between 30% p.a. and 45% p.a. in India. Also, interest is accrued on daily basis which means you pay interest for every single day the outstanding amount remains unpaid. The daily charges may be negligible but when accumulated they can wreak havoc on your budget as well as credit score.

What this means for you?

Banks do not design their credit cards to trick customers. The rate of interest on your cards is clearly mentioned on the documents you receive along with your card. You can also check it online before applying. In fact, banks encourage you to set up automatic bill payment so that you never miss it. A few missed payments can spiral into a debt trap before you notice. So, the best way to stay out of it is to never miss a payment. Pay all your bills on time in full. Set due date reminders or standing instructions for bill payment per month.

• Merchant Fees

When you make a payment using your credit card, the entire amount does not go to the retailer. Banks charge a small percentage of the purchase amount as interchange fee from the merchants. While this may be only 2-3% of the amount but with so many transactions made in a day, it turns out to be a great revenue stream for the bank. However, even the bank does not get the total fee amount to itself; the credit card networks (like Visa and MasterCard) also get a fraction of it.

What this means for you?

Merchant fees only affect the merchant and not the credit card user. Bank and networking companies both deserve to get this fee as they ensure safe and secure transactions between you and the merchant. They also save you from carrying a wad of cash everywhere.

• Marketing Tie Up Charges

This usually happens with co-branded credit cards. With brand competition getting tough, companies like to extend their reach to more consumers through different ways. Collaborating with banks is one such method. Banks launch a credit card with a lifestyle or travel brand and charge fee from the brand as they encourage the consumer to use the services of the brand by offering extra rewards or direct discount.

What this means for you?

Co-branded cards are helpful for you only if you are frequent customer of the brand. When getting such card, do not look only at the brand related benefits; also consider other factors such as annual fee, cash withdrawal charges, etc. While bank does not charge anything extra from you for using a co-branded card, it is always a better idea to compare the benefits before choosing.

So, these are the four main ways how banks earn money through credit cards. None of these charges are unreasonable but you can save yourself from paying extra money by making all bill payments on time, avoiding cash withdrawal and making strategic use of your credit card.