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Getting Rich on Credit

Paying with plastic has simplified our lives -- but it's also made credit card companies very wealthy, and you're paying the price.

Taking a cut from everyone
Many people figure that credit card companies make their money from their cardholders. When the average household with credit card debt owes almost $10,000, paying interest of nearly 19%, you don't need to speak mathanese to figure out that credit cards are a gold mine for financial institutions.

Yet that's far from the only source of income for the credit card industry. On the other end of the transaction, card-issuing banks, along with Visa and MasterCard (NYSE: MA  ) themselves, charge additional fees to the stores that accept credit and debit cards. That may help explain why MasterCard shares have more than tripled since their IPO just last year. Now, those fees have led retailers and other merchants to sue the card companies and their issuing bank partners, including Capital One (NYSE: COF  ) and Bank of America (NYSE: BAC  ) , alleging price-fixing and collusive behavior designed to gouge small businesses.

Big money
You can look at the fee schedule that Visa uses to collect fees from merchants and make payments to issuing banks. As you can see, the fees are extremely complicated, usually involving both a fixed cost per charge and a percentage of the amount charged. Fees generally range between 1% and 3%, but they can vary a great deal depending on certain factors, many of which are beyond a merchant's control. For instance, customers using Visa Signature Preferred cards cost merchants much more than customers with traditional cards.

Businesses that accept credit cards have two choices: Let these charges eat into their profit margins, or pass them on to their customers. Some businesses, especially gas stations, have tried to charge different prices for cash and credit transactions. But this practice has drawn attention from some state regulators, concerned that the higher credit price represents a surcharge on consumers.

Outweighing rewards
Ironically, many people use credit cards as a way to earn cash and other rewards. But if you're getting 1% back while paying 3% higher prices from merchant fees, you'd be better off if plastic didn't exist at all. If a business won't pass on merchant-fee savings by giving you a discount for using cash, however, you're stuck with second-best alternatives.

In the meantime, consumers have little choice but to wait for these legal actions to resolve themselves. Until that happens, the best way to benefit from credit card merchant fees may be to invest in the credit card companies yourself.

Further fully charged Foolishness:

You can get more information about how credit cards work in our Credit Center. You can learn how to get better rates, find the best card for you, and much more.

Fool contributor Dan Caplinger takes his credit card rewards happily, but he often tips in cash. He doesn't own shares of the companies mentioned in this article. MasterCard is a Motley Fool Inside Value recommendation, while Bank of America is an Income Investor pick. The Fool's disclosure policy won't charge you anything.


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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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