Credit cards have become an integral part of our lives lately. Since demonetisation, online transactions have risen considerably and with the COVID pandemic recently, more and more people are opting for cashless transactions.
Credit cards not only allow customers to transact without any cash but also offer a range of discounts, cashback, bonuses, and other rewards. These offers are not only beneficial to customers but also to credit card companies.
But have you wondered if the credit card company is offering a cashback or a discount, how do they benefit? How does a credit card company make money from these?
Let's try and understand
The credit card companies have tie-ups with many merchants and these merchants offer reward points, discounts, or cashbacks.
Different credit cards have different features. Like some credit cards offer more discounts on petrol, some on retail, some for groceries, some on dine-in. So each credit card, depending on its usage and features, has tie-ups with different types of merchants.
These merchants offer such discounts in order to lure more customers to use credit cards. Every time the customer uses their card anywhere, a certain percentage of their bill is transferred to the credit card company as a transaction fee.
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So the more the customer uses a credit card, the more money the credit card company makes. When the credit card offers a discount at any certain partner merchant franchise, a part of the transaction fee paid to the credit card company is shared with the customer. However, such offers increase the temptation of the customer to buy more or dine in more such places, thus increasing the number of transactions and hence the transaction fees for the credit card company.
For instance, a retail-friendly credit card may offer discounts on shopping from Shoppers Stop, WestSide, Max, H&M, etc.
Now suppose your credit card offers a 10 percent discount every time you shop from Shoppers Stop for over ₹1500 to ₹500. Usually, when a customer gets such a discount, he/she will prefer to shop from merchants where such discounts are given.
The more a person uses a credit card, the more transaction fees the credit card company can earn.
Additionally, for credit card companies, the biggest revenue comes from finance charges like interest and late payment penalties.
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So the more a customer uses the credit card, the more the company makes in interest. And if the customer is not able to pay back the total amount for the month, like during festive seasons, the credit card companies also make a lot of money in late payment penalties.
So offering discounts and cashback, not only helps credit card firms get more transaction costs from their partner franchises (due to more transactions) but also increases the interest charged as the amount owed to credit card firms by the customers also increases.
While such offers might tempt you, it is important to use your credit card judiciously and avoid late payments at any cost.