Why it’s important to know how credit card issuers make their money
Introduction
If you’re going to play the points and miles game, it’s important for you to have a baseline understanding of the economics of how credit card companies make their money. It’s important for two simple reasons:
Our goal is to be the credit card companies’ least profitable customers. That’s not to say that we won’t have a mutually beneficial relationship, we will. You will see below that these companies will make plenty off of us. However, it’s important for us to know how credit card companies make their money, so we avoid any actions that only support the credit card companies, and not us. As we utilize sign-up bonuses and maximize rewards, while never paying interest or late fees, we will quickly make our way to the “bottom” of the profitable pack, right where we want to be.
To grow more comfortable in the long-term sustainability of points and miles. When I first got started in this game, I would think to myself, almost daily, “This has to be too good to be true!” However, when you understand how credit card companies make their money, you quickly see that they are doing just fine and the rewards system that they have built is sustainable for both the consumer and the issuer!
How Credit Card Companies Make Their Money
Here is a breakdown of how credit card issuers made their money in 2022:
US Consumer Credit Card Revenues, 2022 (Source: Business Insider)
Studies show that approximately 66% of the U.S. population who possess credit cards don’t pay their credit card balance off each month. It is from these individuals that the credit card companies make a vast majority of their revenues (close to 60%), through interest charges. This is why the golden rule of the points and miles game is that you must pay off your balance in full each month. If you have a history of not being able to pay off credit cards, are in substantial debt, or are nervous about being fiscally responsible with them, I can assure you: the money earned from accumulating points and miles WILL NOT make up for the burden of debt that will be added to your shoulders.
The next highest percentage of credit card issuer’s revenue (33%) comes from the “swipe” fees they earn every time you use you card at a merchant. It is these fees that can help you understand the long-term sustainability of the points and miles game (assuming this legislation does not pass!) Credit card companies profit from most, if not all, of their customers, even as those customers benefit from the enormous sign-up bonuses that the credit card issuers offer.
Let’s use an example to play it all out:
Let’s say you apply for the Capital One Venture X Card. You have never had the card before, so you are eligible for the 75,000-point bonus (the public bonus offer may be different than at time of writing) after spending $4,000 in the first 3 months of holding the card. Let’s say you ONLY spend the $4,000 to trigger the bonus. Here’s how many points you would accumulate:
Everyday Spend: $3,800 x 2 Capital One miles/dollar = 7,600 Capital One miles
Car Rental in the Capital One Travel Portal: $200 x 10 Capital One miles/dollar = 2,000 Capital One miles
SIGN-UP BONUS = 75,000
= 84,600 Capital One miles total
In my research (and personal experience), Capital One miles are valued at as low as 1.45 cents per dollar (Frequent Miler) or as high as 1.85 cents per dollar (The Points Guy), when transferred to one of their hotel or airline partners for a worthwhile award redemption. So, let’s take the average and say that they are worth 1.65 cents per dollar. Those 84,600 miles are worth approximately $1,396.
If you didn’t spend a dime more on the card, after taking the $395 annual fee of the card into account, you are netting $1,001 in value.
Now, let’s see how much Capital One approximately makes on your $4,000 spend. Although sector and sales volume dictate what Capital One gets to charge a retailer every time you make a purchase, healthy estimates are that they will make 3.1% through payment processing (swipe) fees. This comes to $124 on these purchases. These fees are where Capital One receives 33% of their revenue.
However, it still doesn’t represent the big gap between what you are receiving in value and what Capital One is making off of you. Besides the fact that Capital One likely pays airline and hotel transfer partners far less than the 1.65 cent per point value that we are using for our calculations, the biggest gap is that Capital One is hoping to profit from you in three major ways that our calculations do not include:
Interest charges - This won’t be you because you pay off your statement balance in full each month. :)
Late payment fees - Although this is only 6% of their revenue, we are still talking about millions and millions of dollars in revenue for Capital One each year. To avoid late payment fees, set up auto-pay to pay for your “full statement balance” as soon as you register your credit card. (I have been burned by this once, forgetting to set up auto-pay right away. Capital One waived the late payment fee, but you might not be so lucky!)
You hold the card for multiple years, so the cumulative benefit of the sign-up bonus decreases year-after-year with additional annual fees & payment processing (swipe) fees from your purchases.
To avoid the third point, at the end of a cardholder year, always weigh if the value of the card is worth the cost. If it isn’t, then ask for a retention bonus, in either points or decreased annual fee. If one isn’t offered, or if the one that is offered still does not outweigh the value of the card, then seek to downgrade the card to a lower annual fee card in the same family, if available. Otherwise, close it and don’t look back.
Disclaimer: a few credit card companies have a history of “punishing” you for this “burn and churn” credit card philosophy. Capital One is the biggest example of this, but American Express often does this as well. However, it’s worth that risk, rather than keeping a card open that doesn’t benefit you.
Conclusion
It’s important to have a baseline understanding of how credit card companies make their money. Most importantly, you want to make sure you’re not padding their pockets, instead of your own, through interest and late fees. However, it’s also important to know that they are making money off of you, even as you benefit from them, every time they receive the approximate 3% on swipe fees every time you make a purchase. This is sustainably beneficial for both you and the credit card issuer, as long as you: pay off your statement balance in full each month, avoid late fees by setting up Auto Pay as soon as you receive your card, and don’t spend more money on credit cards than you would if you were paying in cash or with a debit card!
