This money comes from both you and the stores where you use your cards. You pay fees and interest.
Many or all of the products on this page come from partners who pay us when you click on their links or do something on their websites. This doesn’t change how we rate or review the products, though. Our opinions are our own.
Credit card companies make the bulk of their money from three things: interest, fees charged to cardholders, and transaction fees paid by businesses that accept credit cards.
Don’t waste your credit cards. If you do, credit card companies will make less money from you.
Using a credit card to make purchases can feel like magic. You just swipe your card or tap your phone, and you’ve bought something without handing over any physical money. But where does that money actually come from? This article will explain the behind-the-scenes process of credit card transactions and where the funds originate.
How Credit Cards Work
With a credit card, you can borrow up to a certain amount of money from the bank that gave it to you to pay for things. This is not the same as a debit card, which takes money out of your bank account.
When you use your credit card to make a purchase, the transaction goes through several steps:
-
You provide your credit card information to the merchant in person, online, or over the phone. This could be by swiping, inserting a chip card, or tapping a contactless card. For online purchases, you would enter the card number.
-
The merchant sends the transaction information to their bank known as the acquiring bank.
-
The acquiring bank routes the transaction to the network shown on your card, such as Visa, Mastercard, American Express, or Discover.
-
The network forwards the transaction information to the issuing bank that gave you the credit card.
-
The issuing bank checks that your account is valid and you have sufficient available credit for the purchase amount
-
If approved, the bank that issued the card sends the money to the bank that acquired it, and your purchase is complete. The amount of the purchase you just made has been taken off of your credit limit.
Where Do Issuing Banks Get The Money?
Banks and credit card companies make money in several ways so they can continue lending funds for purchases
-
Interest fees: If you keep a credit card balance from month to month, you will have to pay interest on that balance. When compared to other ways to borrow money, interest rates are usually pretty high. This interest income is a major revenue source for issuers.
-
Fees – Credit card companies earn fees in various ways, including annual fees just for having the card, balance transfer fees, cash advance fees, foreign transaction fees, and late payment fees.
-
Interchange fees – Every time you use your credit card, the issuing bank collects a small percentage of the transaction amount as an interchange fee from the retailer. This is typically 1-3% of the purchase amount. The retailer pays this fee as part of accepting credit card payments.
-
Merchant discounts – Similar to interchange fees, retailers may pay a small percentage discount on transactions to the acquiring bank. This helps offset the cost of processing transactions.
In essence, the money banks lend you to buy things comes from the money they’ve saved up from interest, fees, and merchant charges. Over time, they want to make money off of credit card accounts.
What About Rewards Credit Cards?
Many credit cards these days offer attractive rewards like cash back, points and airline miles on your spending. This raises the question of where the money comes from to pay for those rewards.
Here are some key facts about rewards credit cards:
-
The issuer is likely paying for rewards partially through the interchange fees collected from merchants. However, rewards costs are not necessarily 1:1 matched to interchange revenue.
-
Limiting interchange fee amounts, like what occurred with debit cards through the Durbin Amendment, resulted in debit card rewards being reduced or eliminated. This suggests interchange plays a key role in funding rewards.
-
Issuers also hope to earn an overall profit through interest paid by consumers carrying a balance. The rewards are meant to attract desirable cardholders who will spend on the card.
-
Customers who pay off their bill each month allow the issuer to collect interchange fees that exceed the value of the rewards earned. So people who don’t pay interest help subsidize the costs.
-
Annual fees on premium rewards cards help cover the higher rewards rates and benefits. The issuers earn money from the fees while also collecting interchange.
Responsible Credit Card Use
While credit cards provide a convenient way to make purchases with borrowed money, it’s important to avoid paying unnecessary interest or fees that cut into your budget. Consider these tips:
-
Pay your statement balance in full each month – This allows you to avoid finance charges while still earning any rewards.
-
Choose cards with no annual fee – Unless you frequently spend enough to justify a premium rewards card’s annual fee.
-
Seek out cards offering an intro 0% APR period – This allows you to pay down a balance over time without accumulating interest.
-
Compare rewards value to the costs – Be sure a card’s rewards outweigh the annual fee and potential interest you may incur.
-
Meet bonus spending requirements through normal budgeted purchases – Don’t overspend just to earn a sign-up bonus.
Using credit cards responsibly allows you to take advantage of convenience, security protections and even rewards while avoiding debt traps through excessive interest and fees. Monitor your credit card balances and payments closely each month.
The Bottom Line
Credit cards provide a revolving line of credit that allows you to borrow from the issuing bank to fund your purchases. While it may seem like magic money, there are real funds being lent by the bank each time you use the card. The issuer hopes to earn a profit through interest, fees and interchange charges ultimately paid by consumers and merchants. With mindful use and prompt repayment, credit cards can be useful financial tools rather than burdensome debt creators.
Interchange
Every time you use a credit card, the merchant pays a processing fee equal to a percentage of the transaction. The portion of that fee sent to the issuer via the payment network is called “interchange,” and is usually about 1% to 3% of the transaction. These fees are set by payment networks and vary based on the volume and value of transactions.
Interchange fees are at the heart of a heated debate in Congress at the moment. The Credit Card Competition Act aims to introduce more competition among credit card payment networks, which proponents argue will help lower the interchange fees that merchants pay. Opponents of the legislation, however, say that doing so could threaten funding for credit card rewards programs.
How credit card companies work
The broad term “credit card companies” includes two kinds of enterprises: issuers and networks.
- Issuers are banks and credit unions that issue credit cards, such as Chase, Citi, Synchrony or PenFed Credit Union. When you use a credit card, you’re borrowing money from the issuer. Retail credit cards that bear the name of a store, gas company or other merchant are typically issued by a bank under contract with that retailer. Hence these are often referred to as “co-branded” credit cards.
- Networks are companies that process credit card transactions. The major networks in the U.S. are Visa, Mastercard, American Express and Discover. American Express and Discover are both networks and issuers.
When you use a credit card, money moves electronically through many hands, from the issuer, through the network, to the merchant’s bank. The network also makes sure that the transaction is attributed to the proper cardholder — you — so that your issuer can bill you.
How Does a Credit Card Work?
FAQ
How do credit cards work?
After you make a purchase, the bank sends your account information to the merchant. The card network then authorizes the transaction, and the merchant gets the money. There are various kinds of credit cards, such as secured credit cards, cash back credit cards, and credit cards with travel rewards.
How do banks make money from credit cards?
The money banks make from issuing credit cards comes from both cardholders and merchants. Profit from cardholders comes mostly from interest fees. However, banks can also profit from annual fees, transaction fees, and penalty fees. Banks will still make money from your credit card account as long as you use it to buy things, even if you don’t pay any fees.
How do store credit cards work?
Store credit cards work like regular consumer credit cards, meaning you can make purchases on the card and then you can pay your balance off either in full, or over time.
How do credit card issuers make money?
Credit card issuers make money from three main sources: Interest. Fees. Interchange. You’re probably familiar with the first two. Federal law requires issuers to prominently disclose these costs in a chart when you get a new card. But the third item, interchange, might not ring a bell. That’s because it’s effectively invisible to consumers.
What happens when you use a credit card?
When you use a credit card, you’re borrowing money from the issuer. Retail credit cards that bear the name of a store, gas company or other merchant are typically issued by a bank under contract with that retailer. Who makes money when I use my credit card?.
Where does the money for credit card rewards come from?
Credit card rewards are paid for by issuers, which pass the bill along to consumers who are charged fees and interest for using their cards. The merchant middlemen also indirectly pay for credit card rewards by paying interchange fees, typically 1. 5 to 3. 5 percent of each purchase that a consumer charges to their card. Sep 30, 2024.
Do credit cards pull money directly from your bank account?
A credit card allows you to borrow money up to a pre-approved limit set by the issuer. Unlike debit cards, credit cards do not pull funds directly from your bank account. Instead, you receive a bill at the end of your billing cycle requiring at least a minimum payment.
Where does money come from for credit?
As such, credit money emerges from the extension of credit or issuance of debt. In the modern fractional reserve banking system, commercial banks are able to create credit money by issuing loans in greater amounts than the reserves they hold in their vaults.
Is money created when you use a credit card?
Each credit card transaction creates a new loan from the credit card issuer. Eventually the loan needs to be repaid with a financial asset—money. To households, the line of credit associated with a credit card is not a financial asset, only a convenient vehicle for borrowing to finance a purchase.