Who pays for credit card rewards?
Key takeaways
- Credit card rewards are paid for by issuers, which pass the bill along to consumers who are charged fees and interest for using their cards.
- The merchant middlemen also indirectly pay for credit card rewards by paying interchange fees, typically 1.5% to 3.5% of each purchase that a consumer charges to their card.
- The best way to maximize your credit card rewards is to keep from paying fees and interest on your card altogether. This way, you’re not spending all your cash back or canceling out your accumulated points value on charges you could have avoided.
Whether it shows up in your inbox or mailbox, you’ve probably received a credit card offer at some point. These offers often have headlines like, “Sign up and get 80,000 bonus points!” or “Earn $300 cash back when you meet the minimum spend requirement.”
Of course, they sound enticing: Who doesn’t want free money or points that will allow them to meet their financial goals or travel the world?
But nothing in life is “free,” right? Technically, credit card companies pay for rewards, but that doesn’t mean those costs aren’t passed on to you, the cardholder. Here’s a look at how the rates and fees you pay as a cardholder, as well as those merchants, pay for the ability to accept credit cards as payment and figure into the real cost of credit card rewards.
Who pays for credit card rewards?
The answer isn’t so simple. On the surface, the bank does. You might feel like rewards are free money — but you do pay for them, possibly in more ways than one.
General rewards cards have their own ecosystems. Co-branded credit cards use the rewards currency of hotel and airline loyalty programs. Card issuers use a portion of swipe fee profits from such cards to buy points or miles from the hotel or airline partner. This alone is a huge revenue source for major U.S. airlines, especially considering interchange fees tend to be higher on premium cards.
But that’s just a part of the equation — and a smaller part at that. If you hold a balance on your credit cards, you’re paying for those rewards in spades. Even if you earn rewards on your purchase, APR charges eat away at your earnings, and the only party that truly profits is your card issuer.
How credit card issuers pay for rewards
Rewards are a tactic card issuers employ to attract and retain customers. They exist to get you to start a relationship with a bank and potentially sell you other more lucrative financial products.
Credit card companies are able to offer this kind of incentive as long as their revenue streams are in good shape. These streams include:
1. Interest
Credit card interest may be the best-known revenue stream for issuers. Interest revenue comprises 80% of card issuers’ profitability, according to the 2022 analysis by the Federal Reserve.
Interest payments on purchases are usually avoidable, as they are applied to outstanding balances. If you pay off your credit card purchases in full and on time each month, you shouldn’t be charged interest on your balance.
Paying off your purchases in full each cycle will usually allow you to avoid interest, but balance transfers and cash advances often begin accruing interest from the date of the transaction. That’s why it’s best to only use your credit cards for purchases or balance transfers during a promotional 0% APR period.
2. Cardholder fees
Credit card fees comprise about 15% of credit card profitability, according to the Fed. They come in various forms, including:
- Annual fees. The price you pay each year to carry the card.
- Late fees. What you pay when you miss the due date for your minimum payment.
- Cash advance fees. A fee for borrowing cash from your credit card, such as using it to withdraw money from an ATM.
- Balance transfer fees. What you pay when you move debt from one credit card over to your new card.
- Foreign transaction fees. A fee assessed when you make purchases in a foreign currency with your card.
Unlike with interest, fees associated with credit cards are not always avoidable.
For people who have a limited credit history or poor credit, subprime cards with fees may be the only option available. On the other hand, many top rewards cards will also come with high annual fees — though savvy cardholders can offset the fees in rewards and perks.
3. Merchant fees
Interchange fees comprise a smaller portion of card issuers’ revenue. And if you subtract the cost of rewards on transactions that earn them, it comes out to negative 4%, the Fed reports. But without the transaction revenue, it’s unlikely card issuers would offer rewards altogether.
In an effort to lower swipe fees, lawmakers introduced the Credit Card Competition Act in 2022. This bill seeks to encourage more competition for credit card processors to lower swipe fees. While the bill has been reintroduced several times, nothing has passed yet. Should it pass, it’s likely to decrease or eliminate rewards on many cards.
How not to pay for card rewards
While you can’t avoid markups where you shop, you might as well earn rewards on your purchases since the cost of interchange fees is baked in regardless. And while you’re at it, here’s how to minimize your contribution to the cost of cash back or points you earn.
1. Know what you’re signing up for
Before choosing your next credit card, make sure you know the annual fee and interest rate associated with the card. High annual fees are one of the most avoidable costs of a credit card, and many great rewards cards charge no annual fee.
That said, if you like what an annual fee card has to offer, it’s important to make sure your rewards will offset the cost.
Some airline cards offer perks like free checked baggage, memberships to ride-sharing VIP programs or airport lounge access, and those perks can be really valuable. But if you rarely use the card, don’t earn many points, don’t use any of the perks and pay a hefty annual fee every year, you might actually be losing money.— Dan Stous, CFP and lead wealth advisor at Flagstone Financial Management
Money tip: If your rewards card offers a welcome bonus, fulfilling the requirements and earning the bonus could help you offset the cost of the annual fee for at least a year or two. Plus, maximizing the rewards program can help you continue offsetting any fees long term.
2. Always pay your balance in full
Added interest can quickly change a credit card from a useful tool to a financial burden. Credit card issuers profit from interest, and some of the most common fees associated with credit cards are linked to late payments. With any credit card, only spend what you are realistically able to pay off in a month, or you run the risk of losing money rather than realizing value from your rewards.
If you need to use a credit card for a large purchase and you know you’ll need to carry a balance, consider planning ahead with a credit card that offers a 0% introductory APR on purchases. These cards won’t charge you interest on purchases, typically for a set introductory period of 12 or 18 months.
3. Don’t chase rewards or premium perks
Remember that rewards should be an added benefit you get on your regular spending. Once you start changing your shopping habits just to earn a bit of extra cash back or miles, you’re on a slippery slope.
Be mindful about annual fees as well. Premium benefits on a credit card should match your existing lifestyle. If you need to make certain purchases you wouldn’t normally make only to justify the annual fee, it’s probably not the right card for you.
The bottom line
Be mindful of the fees associated with your credit card — whether it’s an annual fee, balance transfer fee, foreign transaction fee or cash advance fee — to make sure the benefits of your card come out ahead of the costs. While paying an annual fee is often worth it to get access to generous rewards, frequently paying other fees on your credit card will likely erase your rewards earned and essentially pay for someone else’s.
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