Credit Card – You thought it is free. Is it?

Have you ever wondered why are banks chasing us with flashy credit card offers that come with free membership and mouth-watering free gifts? Here is the simple answer, there is a lot of profit to be made. American Express, the largest integrated card service provider, clocked $4.4 billion of average profit over the past 3 years! So, there is no surprise that banks are after us selling those plastic cards!

But how are they making money? If you are not paying, who is paying? Again, a simple answer, it is us who are paying. Every dime earned by credit card companies come out of our pocket. If you do not believe this, read further for more insights.

Credit Card

Briefly, there are three main revenue streams for a credit card company:

  • Transaction fees (about 60 – 65% of revenue): All credit card holders contribute to this
  • Interest income on outstanding balance (about 25% – 30% of revenue): Levied on those who can’t repay outstanding amount in time (in addition this attracts minimum amount due penalty)
  • Other fees and penalty (about 25% – 30% of revenue): This is mostly penalty charges on overdue amount not paid while rest comes from annual fees paid by some cardholders

So, even those who have not paid any interest or penalty on their credit cards, contribute to about 70% of revenue of credit card companies. This explains why credit card companies usually bend backward to waive off penalty to retain you!

Credit Card

Credit Card Fees and Interest Charges

In the following we will provide detailed explanation and, how can we save money.


  1. Transaction fees:

At times you would have seen merchants flashing a notice saying, “Credit card transactions will be charged 2% extra”. This is because each credit payment attracts a transaction fee of about 2% (in some cases it is 3%) of transaction value. You can broadly split this merchant discount into three component parts – fee collected by card issuer, network charges and fee collected by acquirer / processor.

For better understanding, would like to explain the concept through example. Let us take two transactions, one offline purchase and other online purchase. In the first one, I purchase a pair of Nike shoes at Nike Store using my ICICI Bank Credit Card (powered by Rupay). Let us assume that Nike Store has a card swiping machine (POS machine) provided by HDFC Bank. Here, Card Issuer is ICICI, Network is Rupay and Acquirer is HDFC.

In second example, I pay my fees for a personal loan taken at i2ifunding through PayU using my SBI Credit Card (powered by Visa). Here, Card Issuer is SBI, Network is Visa and Acquirer is PayU. It is PayU because i2ifunding has partnered with PayU for online payment.

In the next section, we will find the amount of fees collected by each of the three parties.

  • Card Issuer: These are banks which issue you the credit card. They collect about 1.2% – 1.7% of transaction value. This is 60% – 70% of transaction fees and there are multiple reasons for card issuers to keep maximum fee. First, they are the ones who service the customers and have incurred substantial costs in acquiring and retaining them. Second, they take the risks of customers defaulting on credit card payment.
  • Network Fees: These constitute players such as Visa, MasterCard, RuPay etc. They charge 0.05% – 0.1% depending on the transaction.
  • Acquirer or Processor: They charge 0.1% – 0.7% depending on the transaction. Acquirers are the ones who process the transaction. They spend considerable resources in acquiring and servicing merchants. It is worth mentioning that in many instances, issuer and acquirer are the same. Card issuer can be ICICI and POS machine can also be operated by ICICI. In such cases, they keep almost all of transaction fees.

One of the questions you may have is why merchants pay 2% fee instead of asking for debit card which attracts about 1% transaction fees or better ask for cash. Actually, in many cases they do! Many merchants provide cash discounts while others like jewelers, doctors etc. charge 2% higher. It is worth mentioning that the government of India, through its Digital India initiative has been working to bring down this 1% transaction cost (in case of debit card) to 0.1% through RuPay cards.

It may also be noted that merchants esp. those dealing in food services, wearables etc. happily accept credit cards as credit cards help increase in sales. This is because often people tend to make impulse purchases where the transaction amount is more than cash they carry, or their debit card can support. It is the credit card that supports such purchase. For example, it is end of month and I am having just Rs. 2,000 in my bank account but want to purchase a wrist watch of Rs. 5,000 which caught my fancy. Now I can easily postpone my purchase but credit card in my pocket doesn’t allow me to do so. I actually end up purchasing a pair of shoes and a nice t-shirt along with wrist watch!  So, it makes a lot of sense for merchants to accept credit card.

To hone this point, try withdrawing cash from your credit card. All the fees come into play instantly! You will be left poorer by 5% of amount you withdrew!

Since you now know that this fee is coming from your pocket, can you do something to save the transaction fees? Yes. Seek for discount for payment through debit card or cash. You will be surprised to find the number of places you get discount. For merchants, they are indifferent between paying transaction fees or giving discount to customers, hence, it is our duty to spend responsibly. Let us remember that money saved is money earned.

  1. Interest on outstanding amount

Paying only minimum amount due looks so attractive. No wonder it is the other major revenue driver is interest charged on credit card balance. The outstanding credit card balance attracts interest rates anywhere from 43% – 50% per annum. This is much higher than personal loan or any other loan available in the formal market. Therefore, Do NOT roll over credit card debt by paying minimum balance. You must re-finance your debt. If your bank is reluctant, go to new age financiers. such as i2ifunding (click here) which go beyond CIBIL score to provide loans. The entire loan funding process is digitized and is transparent, quick and easy, providing borrowers an easy way to refinance debt.

  1. Other fees

This is quite important and usually mentioned in the fine prints which people seldom read. Notice the following often paid charges:

  • Forex transaction surcharge: Do you know that you pay 3.5% surcharge on international transactions when you swipe your credit card? And surprisingly, this is not levied on debit card transactions.
  • Annual fees: In general, first year fee is exempted by credit card issuers. However, we start paying from the second year onwards. Most of the time, fee is adjusted against the points we earn during the year but nevertheless we are out of pocket. The points could have been used elsewhere.

Sometimes, it surprises me that we pay fees to a hold credit card and pay more fees when we use it! And this is the reason why some people are wary of credit card leading to number of credit cards in India being just [10]% of number of debit cards.


To summarize the above discussion, we suggest the following:

  • Hold a credit card with no annual fees
  • For all purchases, check if you can get a discount if you pay by cash / debit card instead of credit card
  • Make full payment of your credit card on time

Hope the above discussion was useful. If you have any further questions, please put it in the comment box below. We will respond at the earliest.

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