Dubai: Credit card companies offer better rewards and signup bonuses, and you as a consumer earn points, miles and cash back. But how do card companies afford to offer such rewards?
Credit card issuers pay for the rewards with revenue primarily from two main sources: the consumer and the merchants who accept their cards.
As a consumer, you pay interest whenever you have a balance on your card and fees whenever your payment is late or you get a cash advance.
Retailers pay card issuers in the form of “interchange” fees, which are set by credit card processing networks like Visa and MasterCard to cover both the risk and cost of processing card payments. credit.
What consumers and retailers do credit card companies pay?
Credit card issuers make money from what you, as a consumer, pay in the form of interest and fees. However, retailers are also charged.
Every time you use a credit card, the merchant pays a fee to accept payment. The portion of the fee that goes to your card issuer, typically around 1% to 3% of a purchase plus a fixed fee, is called the interchange fee.
Compared to the costs of interest charges and fees, which businesses are required to disclose prominently in a table when you get a new card, interchange fees are effectively invisible to consumers.
Rewards credit cards have higher interchange rates
There are many types of interchange rates that can be applied to a credit card transaction depending on the type of business, the type of card used, the amount of the transaction, and how the card is used.
Interchange rates include a percentage of the transaction amount plus a fixed fee. Interchange is just one type of fee that retailers pay to accept credit cards. They also pay fees to credit card networks and their merchant processing providers.
Reward credit cards have higher interchange rates than credit cards that do not have rewards because card issuers must recoup the cost of paying the rewards.
For example, if you used a âVisa Signature Preferredâ rewards credit card to purchase a restaurant dinner, the interchange fee would be 2.40% of your bill plus a negligible charge.
Thus, on a bill of 100 Dh, the restaurant would pay 2.50 Dh. If you have used a card without a reward, this rate can be 1.54% plus the minimum charge, or just 1.64 Dh.
How the cost is passed on to consumers
Retailer interchange fees are just one form of income for credit card companies. The rewards are also funded by the interest and fees that issuers receive from cardholders.
Whenever a consumer carries a credit card balance, interest in the form of a finance charge is applied to that balance.
If you really want to take advantage of your rewards credit card, you shouldn’t have a balance and you shouldn’t be paying any avoidable fees, especially late fees.
If you’re shopping for a new rewards card, look for one with no annual fee, unless you’re sure the rewards you earn will more than outweigh that cost. Always check interest rates and charges on credit card disclosure charts.
Redemption and rewards can go hand in hand
However, interchange and rewards go hand in hand in a key way: Interchange fees and rewards are both tied to purchases. Aside from signup bonuses, both rewards and redemption are expressed as a percentage of a purchase.
You can earn rewards – often 1 to 2% of a purchase – while your issuer collects a similar amount in interchange fees. Interchange fees don’t always cover 100% of the cost of the rewards.
Some cards, for example, offer 5% rewards in certain spending categories, up to a certain spending limit. The issuer would earn much less than that on interchange fees.
Experts say that in some ways the rewards could be a “loss leader.” A âlead productâ is a product or service that loses money but attracts enough customers to offset that cost.
For example, the interchange may not fully cover a cardholder’s rewards, but that customer may end up paying enough interest for the issuer to make a profit on the account.
What does this mean to you?
Credit card companies need money to deliver rewards, but you can still avoid unnecessary fees while earning them:
Pay your balance in full and on time every billing cycle. When you do, you won’t be paying interest. If it is absolutely necessary to keep a balance, go for a no-fee card that offers a 0% introductory rate period, instead of looking for rewards.
Get a card with no annual fee, unless you’re spending a lot. The rewards earned on a card after a year of spending are expected to far exceed the annual card fee. If they don’t, look for a no-cost card with better rewards.
Get a signup bonus with a reasonable spending requirement. A sign-up bonus may be suitable, if you can meet the spending requirements without blowing your budget. If this is not possible, decline the offer.
When an issuer offers a credit card, even with great rewards, it is ultimately looking out for its own financial interests. Before you apply, make sure you research yours.