How do credit card companies afford to “give cash back”? Like how does the process work?



How do credit card companies afford to “give cash back”? Like how does the process work?


They’re charging you interest on any charges that aren’t paid off at the end of the cycle, and it’s significantly more than the 1 or 2% cashback you get.

Additionally, they take an interchange rate from the vendor, usually 2-3%, so they’re making money even if you pay off the complete balance each time.

They make money when you leave debt on the card past the interest free period and they charge you interest. So it’s in their interest to encourage you to spend on the card _just outside your affordability_ but not so far outside that you end up being bankrupt and walk away from the debt entirely (worst case scenario for them). Their basic aim is for you to carry debt on the card that you can afford interest payments on, but can’t quite afford to fully pay off. So “cashback” is effectively them giving back some of the profits they’ve received from charging people interest, but done in such a way so as to maximise more spending.

“Give Cash Back” is a bit of a misnomer. What they’ll do is credit the account some small (1%-5%) percentage of the amount charged, usually from only a few categories of merchant. They’re already charging ~3% in fees per transaction to the merchant, so that’s often enough to pay for the reward. If the incentive gets people to use that particular card more often, or even better, make it their default card for spending even after the promotion is over, they’ll get that money back and then some.

But the real money in Credit Cards is on the interest when a balance is carried month-to-month. Cards will rarely have less than a 14% Annual percentage rate on balances carried. So you buy a $200 steak dinner on your rewards card, get $10 credited to your account, and pay off the balance over 4 months, they’re pulling in a decent profit off of you. And that’s at the minimum APR. If you’ve ever missed a payment, you may have triggered their penalty rates of 30%+.

When you buy groceries for $50, they may only give the grocery store $48 to $49 back. Giving you $0.50 of that $1-$2 looks like a great way to encourage you to use the card more often. Further, if you keep using the card, there’s a chance you’ll pay a late fee or some interest someday, too.

If a bully steals $5 from you and gives you $1, he technically gave you “cash back”.

Card companies often make money because people get in debt and can’t pay it off, having to pay late fees and interest. Vendors who accept cards as payment also have to pay a small percentage to the card company for the convenience of accepting the payment. Very few people out there aren’t paying any interest on their credit card debt.