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How Do Credit Card Companies Make Money on Rewards Credit Cards?

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It’s fair to assume credit card companies make money on interest, given all the facts and figures out there about how much debt Americans are putting on their plastic. But it’s also fair to look at some of the big sign-on bonuses out there and wonder how some issuers break even.

After all, you generally can’t qualify for the best rewards credit cards without a stellar credit score — and people with good credit typically don’t carry balances (at least not big ones, right?) So, how do credit card companies justify, say, offering new cardholders $1,500 in points if they spend $4,000 in three months?

The short answer: they entice affluent customers or frequent fliers — and rely on more than one revenue stream.

Hey, Big Spender

Premium rewards credit cards generate their revenue from annual fees, interchange fees charged to merchants whenever the cardholder buys something from them, and, yes, interest and late fees, according to Eric Lindeen, vice president of marketing for ID Analytics in San Diego, California, which offers fraud prevention tools to issuers.

And because these cards are targeted to people who spend more than $50,000 a year, those annual fees can be set sky-high. (They’re often about $500, but can climb up to $2,500, Lindeen said.) Moreover, all those swipe fees can add up.

“[They] can easily exceed the annual fee for big spenders,” Lindeen said. “Since most card holders rarely use all the benefits available to them, the issuer is able to cover many of the benefit costs with the annual fee and drive revenue on the large spend.”

Plus, premium credit cardholders aren’t immune to mis-steps.

“You would be surprised how often someone [who] has the funds to pay their bills simply forgets to pay on time or relies on automated minimum payments,” Lindeen said.

A Cyclic Effect

Issuers, too, are playing the long game. They offer big sign-on bonuses and load cards with uber-perks — like swanky airport lounge access, free hotel upgrades, and 24-hour concierge services — to win over well-to-do-cardholders. Then they hope the new happy client will generate some brand visibility among their equally wealthy friends.

“Many wealthy card holders love to pursue point promotions and discounted deals,” Lindeen said. “You might think they would have a better use for their time, but it isn’t uncommon for someone with $10 million invested to spend time searching for a hotel discount or drive across town for a free movie screening.”

Pursuing a Premium Credit Card

Of course, the rules of good credit card use are in effect whether you charge more than $50,000 a year or not. While rewards and sign-on bonuses are certainly enticing, it’s a good idea to avoid overspending just to earn those extra points, miles or cash back. You don’t want to wind up carrying a balance because you went over your budget, no matter how big it may be. That’ll easily negate those rewards — and could wind up hurting your credit score.

Remember, for best credit scoring results, you want to pay all of your bills off on time, keep debt levels low (below at least 30% and ideally 10% of your total available credit limits) and avoid applying for every credit card on the market, premium or otherwise, in a short timeframe. Credit card applications generate hard inquiries on your credit reports, which, too, can wind up dinging your credit scores.

When vetting new plastic, it’s important to read the terms and conditions carefully to be sure a credit card is right for you. It’s also important to check your credit before applying. Remember, you generally need a good credit score to qualify for the premium cards on the market, so you’ll want to make sure yours is in tip-top shape before you apply. Otherwise, you risk incurring a hard inquiry only to be rejected. (You can view two of your credit scores for free each month on Credit.com.)

Image: Yuri_Arcurs

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