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Here Is How Credit Cards Really Work, And How Banks And Credit Card Companies Make Money From Us

Now you know why credit card companies and banks are so eager to give us those points, discounts and rewards.

Have you ever wondered how productive it really is for pesky bank employees to stand all day at roadshows trying to sell you credit cards? Or how effective those credit card advertisements that portray it as trendy and a must-have in everyday life really are?

It’s simple, if banks and credit card companies are still doing it, it must be effective and profitable.

The only reason why any company would continue spending money on marketing is because the marketing dollars help them make money. That being said, we look at how these banks and credit card companies are profiting and tell you exactly what happens when you make purchases with your credit cards.

What Is A Credit Card?

Firstly, let’s understand what a credit card is. And no, we do not think our readers are stupid, we just want to get the technicalities out of the way.

Credit cards allow people to borrow and spend money that they don’t own, up to their credit limits, with no interest charged until the payment due date. Of course, missing this due date will trigger hefty interest charges on your balance. This is part of the reason why banks want their credit cards in your wallets. The interests they charge on unpaid balances are lucrative, approximately 24% per annum.

Credit limits are usually determined by your monthly salary and credit history. Having a credit history is both a boon and a bane. If you are paying your credit cards bills, and other bills such as mortgages or car loans on time, then you will be building a good credit history.

Likewise, not paying such bills will mean you would be building up a bad credit history for yourself, which could affect your ability to get more loans in future. A bad credit history could be a real inconvenience if you are thinking of getting a home loan in the future.

Credit cards also offer you a feature that requires only a minimum repayment for your bill each month. This helps you with cash flow difficulties. However, we do not recommend paying the minimum or partial repayment, as you would accumulate more interest, which would make clearing an existing debt even more difficult in the future.

Read also: How Your $10,000 Credit Card Purchase Can Become A Living (And Growing) Nightmare

What Happens When You Use Your Credit Card To Make A Purchase

As described above, consumers who use a credit card for payment are able to get the banks or credit card companies to pay for an item(s) first and then pay back the banks or credit card companies that allowed this transaction to happen later. For consumers, this makes buying easy and hassle-free.

For retailers, they have to pay a transaction fee based on the purchase made. In addition, to even accept credit cards as a form of payment, they also have to install and pay monthly rent for readers to process payments. These are how the banks and credit card companies make their money. It is also the reason why some service providers (i.e. shops at Sim Lim square) would charge you more if you pay using your credit cards instead of cash. However, do note that these are rightfully not allowed under the agreement that these retailers have with the credit card companies.

Differences Between Banks And Credit Card Companies

At this juncture, we will differentiate between a bank and a credit card company. In Singapore, the usual banks that issue credit cards include DBS, UOB, OCBC, Stan Chart, ANZ, CIMB and Maybank while the credit card companies include Visa, MasterCard and American Express. These are all household names that are familiar to us.

Banks will make money through the interest they charge on unpaid or rollover balances. With $288.4 million in rollover balances in Singapore, this amounts to over $69.2 million in interest for banks. In addition, many cards also come with annual fees, supplementary card charges and administrative charges. Whenever you apply for a credit card (particularly in the streets), banks will also try to cross-sell you other (unnecessary) products such as a personal credit line or multiple credit cards, sometimes without even you realizing. One added way they make money is also by charging retailers a rental installation fee for their card processing machines.

Moreover, they try to incentivise clients (us) to spend more money and ultimately indirectly increase the chances of us not being able to repay our balances. They frequently let us know that we only have to pay the minimum amount to keep our credit cards running, and once they realize we’re prudent with paying our balances, they increase our credit limits under the guise of us being good customers.

Read Also: 3 Things Our 10-Year Old Selves Could Teach Us About Financial Planning

Credit Card companies on the other hand, make money in a very different way. They earn from the transaction fee on each purchase made. In Singapore, this was close to $45 billion in credit transactions in 2014. At about 2% charge per transactions, the credit card business is a very competitive and lucrative one.

Note that your Visa and MasterCard credit cards differ slightly from your American express Credit Cards (or most of them). Visa and MasterCard work with banks in providing payment services whereas American Express usually offers standalone cards. Do note as well that Visa and MasterCard frequently split the revenue they collect with the banks that issue the credit cards.

With so many ways to earn revenue by being part of our everyday lives, it explains why so many people would be standing at roadshows trying to shove credit cards down our throats.

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