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You're Still Paying Credit Card Fees Even If You Use Cash

By Adam Levy - Oct 14, 2017 at 7:14AM

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If you can't beat 'em, join 'em. Here's how you can get more back from credit card companies than they take from you.

You might think there are no costs to paying for everything with cash. There are no annual fees, no finance charges, no potential for missing a payment, and no chance of paying interest -- all common fees associated with credit cards.

But paying in cash doesn't let you escape from the impact that card fees have on the prices you pay where you shop, and those costs could be a lot more than you realize.

A 2010 study by the Federal Reserve Bank of Boston found the average cash-using household pays $149 per year in additional costs due to cards. That number stems from the fact that the pervasive use of credit cards drives up prices for everyone, but as we'll see below, only credit card users benefit in the form of rewards.

To understand how paying in cash can cost you money, you have to first understand how credit card companies make money. Then you can make an educated decision on how you can best keep more of that money for yourself.

A woman and man checking out at a grocery store and paying in cash.

Image source: Getty Images

The hidden cost of retail

Every time somebody buys something with a credit or debit card, the merchant pays a fee to process the payment. That fee, called an interchange fee, can vary based on the type of card (credit vs. debit), the payments network (American Express vs. Mastercard), and the type of merchant (grocery store vs. restaurant).

Merchants must incorporate interchange fees into their operations somehow. It's legal throughout the country to offer a discount to customers paying with cash. In some states, merchants are allowed to charge extra if you use a credit or debit card, but many credit card companies impose no surcharge rules. Additionally, these efforts can be a headache to implement, from both an accounting perspective and at the checkout counter.

That's why most retailers incorporate their average interchange fee into their prices. So if the merchant pays an average 2% interchange fee and half of its customers use cards to pay, it'll increase its prices by an average of around 1%.

That means that unless you exclusively shop at cash-only merchants or merchants that offer a cash discount, you're paying more for items than you would if credit cards didn't exist. That goes for both cash users and credit card users. Prices are higher at most retailers because of credit cards.

Banks love interchange fees

Interchange fees make a lot of money for credit card companies. Last year, more than half of American Express's revenue -- $18.7 billion -- came from "discount revenue," its term for interchange fees.

Interchange fees accounted for more than twice the revenue the company generated from interest charges. Fees associated with its credit cards -- annual fees, foreign transaction fees, late-payment fees, etc. -- contributed just $2.9 billion to American Express's top line.

Interchange fees generate a lot of money for the banks that collect them. That's why they encourage cardholders to spend money with rewards. Rewards come in the form of cash back or travel points.

The credit card companies still earn a healthy profit after accounting for rewards they dish out. Last year, American Express gave its cardmembers $6.8 billion worth of rewards. That pales in comparison with the $18.7 billion it took in from interchange fees.

Many credit cards offer sign-up bonuses to new cardholders if they spend a certain amount within a few months of receiving the card. Bigger sign-up bonuses usually require more spending, so the interchange fees can offset a larger portion of the bonus.

Rewards allow credit card users can get back some of the extra money they're charged through interchange fees.

How to take advantage of the credit card companies

The simplest way to start getting some of the money back from interchange fees is to use a flat percentage cash-back credit card. There are several options that can earn you 2% in cash back on every purchase.

A 2007 study from the Federal Reserve Bank of Boston found the average credit card user spends $14,280 per year, that's about $16,830 in today's dollars. At 2% back, that's a cool $336.60 back in your bank account every year, and it should more than offset the costs hidden in retail prices thanks to interchange fees.

If you find yourself spending most of your money in one merchant category, like grocery stores, a tiered cash-back card that offers a little extra for your favorite shopping category may work best for you. Review The Motley Fool's picks for best cash-back credit cards to find the card that's best for your spending habits.

Consumers can earn even more in rewards if they opt to use travel points. Several issuers offer their own brand of flexible rewards points that can be redeemed through travel portals or as a statement credit against qualifying travel purchases.

Issuers also partner with hotels and airlines to offer credit cards that earn points toward the partners rewards program. While it's hard to put an exact cash value on some of these points, consumers should be able to redeem most of them for at least $0.01 each and sometimes a lot more.

Take a look at The Motley Fool's picks for best travel credit cards to find the one that's best for you.

There are also several additional benefits to using credit cards instead of cash. You can't get perks like purchase protection or free warranty extension with cash.

When credit cards cost you more than cash

It's important to remember credit cards come with a lot of pitfalls, which is why many people prefer to stick with cash even though it's costing them potential reards.

If you're susceptible to abusing your credit limit and spending more than you would with cash, you're automatically going to cost yourself more money than if you stick with old-fashioned paper notes. Not only will you spend more, but you could also end up paying interest because you spent more than you could afford to pay off at the end of the month.

On top of that, you need to ensure you use the credit card properly, the way it was intended, or you could get hit with any number of fees: foreign-transaction fees, cash advance fees, and late payment fees, to name a few. Banks will try to find a way to charge you some sort of fee, so be sure to read the fine print.

Annual fees could also make credit cards less worthwhile. If you're not earning enough in rewards to offset the annual fee, it's a losing proposition. Thankfully, there are a lot of great no-annual-fee credit card options.

If you manage your credit cards wisely and make the most of the rewards, you could find yourself to be one of the households receiving benefits from credit card companies instead of paying for them at the register by only using cash.

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