Using a credit card as a method of payment has become so commonplace and seemingly instantaneous that you might not think twice about it. However, there’s an elaborate credit card payment exchange happening in the background that enables you to buy your morning coffee or make an online purchase in seconds.
Providing this service, as well as charging interest and different fees for cardholders, is how credit card companies make money.
Types of Credit Card Companies
You might be keenly aware that you pay your monthly credit card bill to the bank or financial institution that approved your credit card line. However, there are other credit card companies involved in the payments process.
Credit Card Issuers
The credit card issuer is the entity that provided you with your credit card. Major U.S. banks, credit unions, and other financial institutions issue credit cards directly to consumers. Some examples include Chase, Capital One and Pentagon Federal Credit Union.
Credit Card Networks
Credit card networks, also called card associations, partner with credit card issuers to act as a middleman that communicates between your bank and the merchant’s bank. Visa, MasterCard, American Express, and Discover are the four major U.S. card networks.
Some networks also act as a card issuer, offering their own credit card products to consumers. The credit card network also typically determines transaction interchange rates (more on this later), relays whether a charge was approved or declined, and identifies potentially fraudulent activity on a credit card.
Credit Card Processors
As its name states, a credit card processor is the company that actually processes the transaction between the issuing bank and the receiving bank. Some examples of credit card processors are Stripe, PayPal, Block (formerly Square), and Elavon.
Additionally, some credit card processors ensure that the merchant and transaction are secure and compliant under the Payment Card Industry Data Security Standard (PCI DSS).
How Credit Card Companies Work
All of the types of credit card companies above work in unison so you can successfully pay for goods and services using a credit card as a cashless payment option. There’s a lot of back-and-forth communication between the three types of credit card companies after you provide your credit card to a merchant.
The process starts with obtaining authorization, which the merchant requests from its payment processor after a customer swipes or taps their card to pay. The card processor then submits your credit card information and transaction details to the card network. Your card’s credit card network routes this information to your issuing bank. The issuing bank either approves or denies the transaction based on your available credit and the status of your account.
If approved, your bank sends the approval to its partner credit card network. The card network then communicates the approval to the merchant’s bank. The merchant’s bank relays the approval to the merchant, so you can finally walk away with your purchase or close the transaction.
Although you walked away with your item or completed the online checkout process, the merchant doesn’t get your payment in their account instantly due to how credit cards work. Instead, the merchant goes through a separate process afterward to settle and receive funds for the authorized transaction. The transaction and payment details of transactions are communicated through the same channels that were used for authorization, involving the credit card network and issuing and merchant banks.
After the issuing bank draws the funds from your credit card account, it transfers the amount to the merchant’s bank, but withholds an interchange fee.
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How Credit Card Companies Make Money From Cardholders
Credit card companies tack on various credit card charges as part of their business. Below are three ways that credit card companies make money from their customers and from each other.
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As you use your credit line, credit card interest charges apply when all or a portion of your statement balance rolls into the following month. This interest is expressed as an annual percentage rate (APR). Credit cards typically have a variable APR that changes depending on market conditions, your creditworthiness, transaction type, and borrowing habits.
Your credit card issuer also makes money from charging you other fees related to your credit card use and borrowing habits. For example, if you open a new balance transfer credit card, making a balance transfer — which involves paying a credit card with another credit card — typically incurs a fee.
Similarly, your card issuer might charge a fee if you authorized a transaction in a different country; this is commonly called a “foreign transaction fee”. It might also charge you annual fees, cash advance fees, returned payment fees, and late fees.
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How Credit Card Companies Make Money From Merchants
The acquiring bank, issuing bank, and credit card network all make money by withholding a small percentage of the authorized transaction amount from the merchant.
Called the “merchant discount,” this fee combines various costs, such as interchange fees. The rate per transaction is determined by the credit card network. The merchant’s bank deducts the fee from the authorized purchase transaction amount, sending the remaining funds to the merchant.
This fee is then divided between the acquiring bank, the card network, and the issuing bank. The issuing bank makes the most money from interchange fees because it assumes the most risk throughout the process if you default on the debt.
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Limiting the Amount Credit Card Companies Make From Cardholders
To avoid credit card interest charges, make a credit card payment for your entire statement balance every month. Additionally, using a credit card responsibly, such as by not exceeding your card limit, can help by avoiding an APR increase.
It’s also worthwhile to examine the features of your existing and future credit cards. Consider cards that impose limited fees, such as those that don’t charge annual or foreign transaction fees, for example. Also don’t forget the credit card rule that you can always negotiate on fees or interest for your credit card.
There are many ways in which credit card companies make money through your purchases, both from you and the merchant you patronize. However, you can reduce how much your credit card companies make off of your purchase by paying your credit card bills on time and in full every month.
The SoFi Credit Card offers unlimited 2% cash back on all eligible purchases. There are no spending categories or reward caps to worry about.1
Who profits from credit card convenience fees?
A convenience fee charged at the checkout counter is meant to benefit the merchant. Since merchants pay interchange fees for the ability to accept credit card payments, a convenience fee is a way for the merchant to recoup lost funds from credit card transactions. It’s also designed to discourage customers from using their credit card for payment.
Do credit card companies make money if I pay off my balance every month?
Yes, credit card companies still make money even if you pay off your balance each month. They achieve this through various fees. For example, a card issuer might still charge you an annual fee to use its card product or a foreign transaction fee if you use your card abroad. Similarly, a credit card network and credit card processor charges the merchant fees for the benefit of accepting credit card payments.
How do credit card companies make money if they offer cash back?
Despite offering you cash back on your card purchases, credit card issuers can make money through fees and interest charges. It will charge you interest if you’re unable to pay your statement balance in full each month, and you could face fees, such as a balance transfer fee, late fee, annual fee, or foreign transaction fee, depending on what may apply to your situation.
Photo credit: iStock/Talaj
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1 When you elect to redeem rewards points as cash deposited into your SoFi Checking and Savings account, as a statement credit to a SoFi Credit Card account, as fractional shares into your SoFi Invest account, or as a payment toward your SoFi Personal Loan or Student Loan Refinance, your rewards points will redeem at a rate of 1 cent per point. For more details please visit the Rewards page. Brokerage and Active investing products offered through SoFi Securities LLC, member FINRA/SIPC. SoFi Securities LLC is an affiliate of SoFi Bank, N.A.