How Credit Cards Make Money and Why You Can Be Stuck in Debt

There’s no denying that credit cards are great to have on hand. They let you cover emergency costs, help you pay larger purchases in small increments and many offer cash back, airline miles, hotel stays and even gift cards as a reward for spending. And let’s not forget that credit cards are a huge factor in your credit score, which impacts your ability to buy a home, purchase a car, or get a loan.

But all of your spending doesn’t come for free. Credit card companies are ultimately businesses - and business is good. In 2016 alone, credit card companies raked in $163 billion, which is a pretty nice payday.

So how exactly do credit cards make money, and why does it matter for your own financial health? There are plenty of fees and fine print that go into keeping these companies profitable—and simply put, it can add up to big costs on your end. Similar to when the government mismanages their own federal budget.

Once you know how credit cards make money, you’ll be much better prepared to find the right credit card for you and to make smart decisions for your financial health. In the sections below, we’ll show you exactly how credit cards make money and what that means for you. We’ll also talk about common debt cycles that credit cards start and show you how to avoid them (you can do this!).

How Credit Cards Make Money From Cardholders

You might not be surprised to learn that you, the cardholder, are a big source of income for credit cards. After all, that line of credit doesn’t come for free—there are tons of related costs that you will be paying for over the life of your card. These are the most common costs that generate income for credit card companies:

Interest rates

Credit cards come with interest rates, which can be higher or lower depending on factors such as your lending history and your credit score. The good news about interest is that it only kicks in on the balance that you are carrying when each statement ends. If you pay off your credit card balance every month, you can avoid those fees entirely.

If you’re like most Canadians, however, you probably carry a balance from one statement to the next. And those interest fees on each statement are going directly to credit card companies as income.

Annual fees

Not all credit cards are created equal: many cards come with an annual fee, which means you will pay an additional fee just for the privilege of keeping your line of credit open.

How much are credit card companies making off of annual fees? Well, there are a lot of variations from one card to the next. For example, the Capital OneⓇ VentureⓇ Rewards card has a $95 fee each year, while the American Express Business PlatinumⓇ card will cost you a whopping $595 annually (ouch).

Travel cards, rewards cards and secured cards all tend to come with annual fees. In most cases, the annual fee is higher depending on the types of rewards and perks offered by the card—so annual fees aren’t really a bad thing. And if a credit card offers some truly amazing rewards, it might be worth it to pay a little extra.

Annual fees are usually tacked onto your credit card balance automatically each year. You won’t have an extra bill to pay, but you will want to keep a close eye on your spending and make sure you aren’t maxing out your card before the annual fee is processed (maxing out your card is never a good idea, but especially not before your annual fee hits!).

If you’re signing up for a secured card or a card for bad credit, you might not have a choice when it comes to annual fees—but at the very least, you can be aware of the cost of your fee, when it will be processed, and know exactly why your balance is going up.

Foreign transaction fees

If you are a frequent traveler, you’ve probably already come face-to-face with the dreaded foreign transaction fee. A foreign transaction fee is exactly what it sounds like: you get charged for swiping your card while in another country. This varies from bank to bank, but the fee can be between 2 to 3 percent of the total transaction cost.

Not all credit cards have foreign transaction fees, and it’s not always something that cardholders know to look for. If you plan on using your card outside of Canada, you’ll want to make sure that your credit card doesn’t have a foreign transaction fee.

Balance transfer fees

There are typically two options for transferring a balance: you can take out a short-term loan to cover the cost of your credit card, or you can take out a new card and move that balance over. Transferring a balance from one card to the other can be a smart move if you can get a good promotional deal (like 12 months without interest).

The best way to do a balance transfer is to take the total amount owed on a credit card with a high interest rate, and transfer that balance to a new card. Your credit score might take a tiny hit from opening up that new card—but you’ll save a ton of money on interest, which makes it easier to pay that balance down over time.

Of course, when it comes to credit, nothing is free. Most cards have a balance transfer fee, which means you’ll pay anywhere between 3 to 5 percent of the total balance. Compared to the benefits of avoiding high interest rates, it’s a small price to pay—but balance transfer fees are still a great money-maker for credit card companies.

Late payments, cash advances, and overlimit fees

These are the fees that all come down to how you manage your credit card. Making a late payment can cost you anywhere between $25 to $35, so if you’re not paying your bill on time, you’re going to get some extra costs tacked on (which is good news for credit card companies).

And while you can certainly take out a cash advance against the available limit on your credit card, that convenience is going to cost you. You’ll get a higher interest rate on that cash, usually around 22 percent or more.

Overlimit fees happen when your transactions exceed the actual balance that you have available. Some credit cards will deny a transaction when this happens—but not all of them will. Just as with your debit card, you’ll get an overdraft fee from going over your limit on your credit card (which is extra incentive to keep an eye on your credit limit).

Why You Can Easily Get Stuck in Debt

It’s good to have at least one credit card in your wallet as a safety net (hey, we all need one from time to time), but credit cards can be a double-edged sword. If you aren’t careful with your spending, you can easily find yourself stuck in debt. Here are the most common reasons that Canadians find themselves struggling with credit card debt:

Making only the minimum payment

Minimum payments are different for every card, and typically depend on the overall balance that you are carrying at any given time. Once you see that “minimum payment” requirement, it’s tempting to only pay that amount—but it’s a common mistake that can often lead to higher debt over time.

If you are only making the minimum payment, you aren’t going to make much of a dent in your balance. In fact, you’re making your balance even higher over time. Paying the minimum balance means you’ll take longer to repay the full amount, meaning you’ll have more interest payments...which leads us right into our next reason that credit cards can get you stuck in debt.

Compounding interest charges

Interest is a necessary evil in order for credit card companies to make money, but it can quickly get out of hand if you aren’t careful. Credit card interest is compounded daily, which means you will get charged a percentage of your purchases based on your average daily balance.

This is a non-issue if you pay off your entire credit card balance before your statement end (and kudos to you for being so responsible!), but most Canadian consumers carry at least some balance from one statement to the next. And compounding interest will continue to be calculated from one statement to the next, which can be costly.

Let’s say you purchased a new TV on a credit card for $500, which you plan to pay back over time instead of paying the entire balance off right away. With a 12 percent interest rate, you’ll have an additional $60 to pay, making your actual cost $560. And if you make only the minimum payment (which could be $25 or $35), you won’t even be touching that original $500 that you charged for your TV. Over time, those interest costs can really add up and make it harder to pay what you owe.

The best way to get around this is to make more than the monthly minimum payment—and if you can, make more than one payment within your statement. This decreases the average daily balance and means you’ll pay less in interest. Even celebrities or someone with a famous personal brand has to pay interest. We all do.

Impulse, big-ticket purchases

When you see something that you love—like a designer purse, a pair of shoes, or an entertainment system—and your bank account is low, it’s so easy to pull out that credit card. Having a line of credit makes impulse spending easy; but that also makes it much easier to get yourself into more debt than you can manage.

If you’re spending way more than what you can afford to comfortably pay back each month, you could soon find yourself buried by monthly payments and interest. This isn’t to say that you can’t use a credit card for larger purchases—it only means that you need to make those purchases wisely. Keep the big picture in mind and spend only what you can afford to pay back in a reasonable amount of time.

Credit cards can be a great way to build your credit score, rack up reward points, and cover emergency purchases. But if you find yourself getting overwhelmed with your credit card payments, you may want to consolidate them with a payday loan. My Canada Payday works with borrowers across Canada to help them regain control of their finances. Call (604-630-4783) or email (getpaid@mycanadapayday.com) us at any time to get in touch with our support team and find out why thousands of Canadians keep choosing My Canada Payday for their short-term loans.