Credit cards have gained much popularity in India over the last few years. Public sector banks as well as private banking institutions have come forward to launch a host of credit cards suiting customers with different types of needs. HDFC Credit Cards and SBI Card are the two companies with the largest market share. While banks are ready to offer you with a small loan in the form of credit cards, have you ever wondered how these banking institutions make money from these ventures?
The three main ways how card issuers make money is through the annual fee of the card, interest charged on late payment, penalties on skipping EMIs, etc. At the same time, they also earn from the businesses that accept these cards. Businesses are required to pay transaction fees to the banks which also makes up for significant earning of the card issuer banks.
But before we dig deeper into how they make money, let us first understand the term 'Credit Card Companies'. It is easy to get confused between credit card issuers and credit card networks. An issuer is the bank or financial institution from which you take the card. You are taking a loan from the card issuer and paying back to them. A credit card issuing company is usually a bank. On the other hand, credit card network refers to companies that process the transaction. Currently, there are three major networks in India- VISA, Master Card and RuPay. Apart from these, American Express and Discover cards can also be found.
So, when you make a transaction with your credit card, your money moves electronically from your bank through the network to the merchant's bank.
How do credit card companies make money?
As mentioned above, your bank makes money majorly from you and also from the merchants where you use the card issued by the bank to make the payment. Banks or financial institutions make money in the form of-
Banks charge different types of fees from their cardholders- some fees are to be paid by everyone whereas other types of fees are levied on condition. Let us talk about these fees and charges-
- Annual Fees- You have to pay annual fees towards your credit card, especially when you are an elite cardholder and enjoy higher benefits than normal users. This is to be paid by all users. However, some banks may set a condition of spend based annual fee reversal scheme.
- Cash Advance Fees- When you withdraw money from an ATM using your credit card, the bank charges a minimal fee for it which is normally correlated to the amount you withdrawal. This is also included in the card issuer's earnings.
- Late Fees- Your card issuer charges fees from you if you delay your EMI payments. Banks make more money from late payers in the form of late fees.
- Balance Transfer Fees- When you transfer outstanding balance from one card to another, the bank charges fees from you which again becomes its earnings.
The bank or financial institution has just gifted you a credit line. You have to pay the interest for the loan that is offered to you in the form of credit card. This interest cost adds to your expenses and is a method of earning for the banks. Interest on credit card is charged on daily basis for as long as the amount stands outstanding in your account. This is why experts always advise you to pay the total outstanding amount in full every month because interest will accrue on any amount that stands unpaid.
Let us understand this with the help of an example. Suppose the billing date is on 4th of every month and payment due date falls on 29th of every month. APR = 24%
- 10th March- Apparel Shopping- Rs. 5,000
- 13th March- Bill Payment- Rs. 2,000
- 19th March- Gadget Purchase (converted into 6 month EMI) – Rs. 12,000
- 22nd March- Dining Bill- Rs. 1,000
Now considering that the person does not have any outstanding amount from the previous bill, he will have to pay Rs. (5,000 + 1,000 + 2,000 +2000) = Rs. 10,000.
This will be the total amount due on 29th March. Now if the person chooses to pay only Rs. 6,000, the remaining Rs. 4,000 will accrue interest for each day until the amount is paid in full. Considering that the user again pays Rs. 2,000 on the 10th of April, let us see how interest cost works out-
Interest = (outstanding amount x 2 percent per month x 12 months) * (number of days) 365
In this case, the total interest charged would be Rs. 52.60 which is a total for Rs. 4,000 that lies outstanding for 11 days and Rs. 2,000 that lies outstanding for 18 days until the next payment. This is the reason why those who only pay minimum amount due tend to fall into debt soon sooner. Cardholders should also note that when an amount is outstanding in your statement, the new purchases that you make are not eligible for the interest free period. This is why interest charge is the easiest way how banks make money out of your credit card.
Interchange Fee from the Merchant
When you use your card at a merchant terminal, the merchant also pays a percentage of the amount to the bank as processing fees. This will also be added on to the bank's earnings. It usually ranges between 1 to 3 percent of the transaction value but may differ from merchant to merchant.
How to save yourself from paying too much to the bank?
Savvy customers plan their transactions and payments in a way that they have to pay the least amount to the bank. These are the habits you can adopt to cut your costs-
- Pay your entire outstanding balance every month; just pay the minimum amount due is not a good practice.
- Set alerts for your payment due dates to avoid missed payments which entail late fees.
- Create an emergency fund to replace costlier options like cash advances from credit card.
- Choose low annual fee or free credit cards and even if you select a card with high annual fee, make sure that the rewards are worth it.