Question of the Day: How Can Credit Card Companies Make Money With Their Cashback Rewards Programs?
Hint: Think how profitable it is to lend money at 14% interest rates for those cardholders who don’t pay their balance in full every month.
Answer from Investopedia:
- Sharing fees they collect from merchants: “When merchants accept payment via credit card, they are required to pay a percentage of the transaction amount as a fee to the credit card company. If the card holder has a participating cash back rewards program, the credit card issuer is simply sharing some of the merchant fees with the consumer. The goal is to incentivize people to use their credit cards when making payments rather than cash, which earns them no rewards. The more that a consumer uses a credit card, the more merchant fees the credit card company can earn.”
- High interest rates make for a very, very profitable business so encouraging people to use their cards may lead to larger balances (and more interest collected by credit card company): “Additionally, credit card companies make money by charging high interest rates on credit and issuing late fees for balances that carry over from month to month. The more a consumer uses their credit card, the more likely it becomes that they will miss a payment or carry a balance for which they will owe fees and interest. According to the Federal Reserve, the average credit card interest rate is 13.68% APY with almost $900 billion in outstanding revolving credit. Furthermore, according to Statistic Brain, 56% of all consumers carried a credit card balance over the past 12 months, with 26% of those balances increasing rather than getting smaller.”
Want to understand how credit card interest can add up? Check out the NGPF Activity “Shopping With Interest”
About the Author
Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.