These days, getting a credit card has become a priority for all of us. Everyone wants to know how to use credit cards smartly and which one is the best?
But have you ever wondered why banks often offer credit cards for free? And even if they charge a basic annual fee, how can they afford to offer so many rewards?
In this post, we’ll take a closer look at why banks offer free credit cards and how they make money from them and can afford to offer so many rewards.
Estimated read time: 3 minutes and 36 seconds
Buckle up, here we go!
Credit cards have become an integral part of most of our lives, whether we need to make a big purchase, pay for everyday expenses, or book a vacation. Many people have started using credit cards as their emergency funds – which we do not recommend.
In the past few months, you would have received a call from banks saying they offer a lifetime free credit card, right? And if you want a premium credit card, they charge an annual fee. But it can be waived off based on usage.
All this will tempt you to get a credit card because you have seen so many people saving a lot of money through them and buying free stuff from rewards points.
But why do banks offer free credit cards?
Banks offer credit cards for free because they want to attract customers like us and build relationships with us. By providing a credit card for free, a bank can lure us to sign up for an account or encourage us to use their credit cards more frequently.
Because banks love nothing more than frequent transactions. We will discuss why in a while.
A credit card is like showing you a door to heaven. Once you enter, they have the opportunity to sell you their other services and make you a loyal customer.
In addition to building relationships with us, banks also make a lot of money from credit cards. But how?
How do banks make money from credit cards?
1. Interchange fee or Merchant Discount Rate (MDR) on transactions
If you have been using a credit card for a while, you would have come across some shopkeepers who refuse to accept credit cards or ask for an extra 2-3% for paying them through credit cards.
Do you know why?
Because whenever you swipe your credit card at a shop, a few things happen at the back end. Three entities – your credit card issuing bank, card network (Visa or MasterCard), and the swipe machine providing bank (Acquiring bank) work together in the back end to confirm you have enough balance and the transaction takes place smoothly.
For their service, they charge a small fee of around 1 to 3% called an interchange fee or MDR. They charge this fee to the shopkeeper or merchant. And this eats into the profit margins of the merchant.
This is why we told you banks love frequent transactions. They earn money on every transaction of yours.
2. Interest charges
Banks provide an interest-free period of 30 to 45 days on credit cards. And most people use credit cards for this interest-free period benefit.
Banks are smart. They know at some point, you will forget to pay on time. And that’s when they make most of their money. They charge you a high interest ranging from 2 to 3.5% monthly.
Interest charges make up more than 45% of the bank’s revenue from credit cards.
3. All kinds of fees
If you start defaulting on your credit card debt, it would surprise you to see how banks can add different kinds of fees to earn money.
First, they charge you late payment fees if you default. And if you try to convert your outstanding balance to EMI, then they charge you a processing fee and interest on the EMI. The interest rate is higher than the interest rate charged on a personal loan.
Not only this, if you withdraw cash from credit cards, you pay a fee. You transfer your outstanding balance to another credit card; you pay a fee.
Don’t forget the annual fee charged on credit cards. Most of it gets waived off, but still, they earn a lot from these fees.
4. Branding commission
Banks collaborate with your favourite brands, like Amazon, Myntra, etc. to offer a special co-branded credit card.
Also, they tie up with brands to offer freebies, cashback offers, EMI offers, etc.
All this leads to a good commission income for the banks. And these promotions lead us to transact and spend more on our credit cards.
So you see how banks earn money from you. Most of their earning comes from the interest charges when you default on your credit card. But even when you pay them on time, they earn money from transaction fees and commissions.
And through all these earnings, they can afford to provide many rewards and other benefits on their credit cards.
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