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Credit Card Fees and Interest

How Credit Card Issuers Earn Profits
Credit card issuers (banks) cover their costs (including the interest costs for the money that is paid to merchants prior to the bank being paid by customers), and earn profits, by:

Interchange fees. Interchange fees are charged by the merchant's acquirer to a card-accepting merchant as component of the so-called merchant discount fee. The merchant pays a merchant discount fee that is typically 2 to 3 percent (this is negotiated), which is why some merchants prefer cash, debit cards, or even checks. The majority of this fee, called the interchange fee, goes to the issuing bank, but parts of it go to the processing network, the card brand (Visa, MasterCard, etc.), and the merchant's acquirer. The interchange fee that applies to a particular merchant is a function of many variables including the type of merchant, whether the cards are physically present and the card's magnetic stripe is read, the specific type of card, etc. For a typical credit card issuer, interchange fee revenues may represent about fifteen percent of total revenues.

Charging interest on outstanding balances. Customers who do not pay in full the amount owed on their monthly statement (the "balance") by the due date (that is, at the end of the "grace period") owe interest ("finance charges"). These customers are known in the industry as "revolvers". Those who pay in full (pay the entire balance) do not. These customers are known in the industry as "transactors". Interest charges vary widely from card issuer to card issuer. Often, there are "teaser" rates in effect for initial periods of time (as low as zero percent for, say, six months), whereas rates for those with poor credit can be as much as 29.74 percent (annualized). In the U.S. rules governing interest rates are set at the state level; some banks have chosen to establish their credit card operations in states such as South Dakota that have less restrictive limits on interest rates.

Fees charged to customers. The major fees are for (1) payments received late (past the "grace period"); (2) charges that result in exceeding the credit limit on the card (whether done deliberately or by mistake); (3) cash advances and convenience checks (often 3 percent of the amount); and (4) transactions in a foreign currency (as much as 3 percent of the amount; a few financial institutions charge no fee for this).

Credit card companies generally do provide a guarantee the merchant will be paid on legitimate transactions regardless of whether the consumer pays their credit card bill. However, credit card companies generally will not pay a merchant if the consumer challenges the legitimacy of the transaction and will fine merchants who have a large number of chargebacks.

Credit Card Company Risks
In recent times, credit card portfolios have been exceedingly profitable to banks, largely due to the booming economy of the late nineties. However in the case of credit cards, such high returns go hand in hand with risk, since the business is essentially one of making unsecured (uncollateralized) loans, and thus dependent on borrowers to not default in large numbers.

In some areas, such as Ireland, governments profit from credit cards through the imposition of a stamp duty or credit card tax. This is usually done where a cheque tax previously existed.


This article is licensed under the GNU Free Documentation License.

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