The True Cost of Credit

My former student Sean Harper has put together a nifty little web site,, that allows you to see how much merchants are charged when you use your credit card.

I was surprised at how high the fees were. For instance, in this example of a Mastercard, when you buy a $1.50 pack of gum at a convenience store, the credit-card company gets 28 cents. Even on big-ticket items like airline tickets, the credit-card company collects nearly 3 percent.

This is not to say that there is anything wrong with those fees. I presume that the issuing banks can choose their own fees (within reason), and that there is more or less free entry — which suggests that the industry should be pretty competitive. Merchants accept credit cards, which implies that the benefits of doing so outweigh the costs.

Nonetheless, credit-card fees turn out to be a big cost of being a retailer. According to the numbers at the web site, if everyone used a credit card when shopping at Best Buy, credit-card companies would collect roughly $1 billion a year in fees from Best Buy.

(See also a nice post on about


I guess a part of this amount is due to fraud and the relative risk of credit card payments -- the other part of course for the fact that you pay one month after the purchase.

Here in Europe people usually use Maestro cards as method of payment. There are some differences to credit card. First: you are billed usually one to three days after the purchase. On the other hand the cost of the transaction for the retailer are either a fixed percentage (0.25 to 1%) if PIN codes are used or a fixed sum of 0.05 to 0.50 Euro cents if signature is used. The difference is that payments with signature lay a far greater risk to the retailer while payments with PIN are expensive but there is no risk for the retailer.

Of course every retailer who allows payment by Maestro usually is able to accept credit cards. So when purchasing goods worth over 100$ it is a good idea to ask for a discount for payment by Maestro if a retailer accepts credit cards. He'll usually pass you the difference he would pay more for the creadit card transaction.



I used to work as management in several retail companies. I know to some people this sounds like the credit card companies are taking a lot of money from the retailers. But when you think about the idea that a lot of products in retail stores have between a 150-300% mark-up from wholesale, most retail companies are still making plenty of profit off of you, even when you use a credit card.

So I have very little sympathy for the complaining retailers. In fact, given the knowledge that consumers spend more on credit card than they would have if they only used cash, I think the retailers in the big picture are making more money by accepting credit cards then they ever would by being cash only.


There really isn't free entry into the credit market. The existence of the companies in the field is based solely on build up of early market share. Now it is impossible to gain entry. In addition, the market is run like an oligopoly that exists to increase market share. Instead of reducing the fees, the companies provide cash back to the individuals which in turn causes them to increase their usage of the card.

Credit card companies have businesses by the balls.


I imagine the cost of cash isn't zero either, if everyone used credit cards, you wouldn't need to count, secure and transport the cash you need for a business.


Credit has become like a disease, credit cards are a total robbery, the problem is that after spending with them, people realize that is an extension of their incomes and thats what is so harmful. Credit is a multi billion business and people should find out the dimension of this or spend your hole life making bankers rich.


There's a cost to other transactions, of course. Cash transactions require the cashier to make change (and have enough change on-hand) and require someone to deposit that cash in the bank, and may require a safe, and carry the risk of additional errors and theft. Checks take much longer to process, and therefore require higher labor costs. Check payments are also much more likely to be invalid, and therefore result in no payment.


And since these fees would obviously cause prices to go up, I wonder if, factoring this in, if we would have had net deflation, or at least very low inflation, over the past decade or so... despite tripling the currency supply.


I disagree with the idea that the credit card business is easy to enter, or competitive. It's difficult to get retailers to take your card, and requires going around and asking all of them. Even for companies like American Express, one of their biggest costs is going out and getting businesses to accept their cards (and AmEx's higher fees).

As for competitive fees, regular card fees are only 1.5%, but rewards cards are up to 3.5% and their costs are borne entirely by retailers, not by the card issuers.

The credit and charge card industry is huge, as are their profits, which are earned on a non-service. Retailers provide goods, and have to take a haircut of up to 3 points as a "handling fee" for these cards. That is criminal. My family's grocery store went from almost 100% cash 20 years ago, to less than 50% cash today. That is a result of lifestyle changes by consumers, and the fact that no one carries cash anymore.

Indeed, I think that the solution needs to be the introduction of new, low cost credit cards by a large business like Wal-Mart, who could afford to enter the business. Wal-Mart already struck a blow for the small retailer and large retailer alike, when they got debit card purchases down to a fixed cost and off of a percentage--like a check.



As a consumer, I wonder if there is some way to take advantage of this cost by paying in another method with lower transaction costs. Since haggling is not common in the US, and fixed prices are the norm, how could a consumer request a discount for paying with another method (as with the Maestro card discussed above).


The issuing bank makes most of the interchange amount. The credit card company and merchant bank make a relatively small slice. Out of the issuer's share comes the cost of money (typically about 25 days), fraud/bad debt losses, processing costs, and rewards.


This is why I have switched over to paying small local merchants and service providers with cash.

Adam Roberts

I suppose retailers can't really complain about the cost of processing credit cards. But when banks *encourage* people to use their debit cards as credit cards, I take issue.

Case-in-point, Wells Fargo. I recall a few years ago they had a marketing campaign encouraging people to "tell the cashier to push the 'credit' button" when they used their debit card. "The money comes from the same place." The gimmick was that for every time you used your debit card as a credit card, you got entered into a drawing for something. The only true winner was Wells Fargo. Each time someone used their Wells Fargo debit card as a credit card, the retailer had to pay the credit card processing fees. So essentially Wells Fargo was ripping-off the merchants who use their card processing service.


I think that many businesses can't afford NOT to accept credit cards. I use credit cards for convenience (paying off my balance every month) and hardly ever have much cash, if any, on hand. So if a business doesn't take my credit card, I go somewhere else. I think there are a lot of other people like me.

Nicolas Ward

As a consumer who is very close to living completely cashlessly, the convenience of using a credit card for almost all transactions trumps all other considerations. I would happily pay the 3-5% more for most items/services to cover the transaction fee.


The solution is obvious: forbid the banks to charge the merchant so that the person chooses his credit/debit card as a function of the fees.


"This is not to say that there is anything wrong with those fees. I presume that the issuing banks can choose their own fees (within reason), and that there is more or less free entry - which suggests that the industry should be pretty competitive. Merchants accept credit cards, which implies that the benefits of doing so outweigh the costs."

Actually, that isn't quite right. Card issuers and the banks that set merchant fees are different in most transactions. So the direct cost is set by the merchant acquirers. Card issuers do receive part of that cost through interchange fees paid to them by the acquirers. But individual card issuers don't get to set those. They are set by the system -- MasterCard, Visa, AmEx -- and so are the same regardless of which bank's card you actually hold. It is the whole two-sided thing that leads to them agreeing to interchange fees that continually mean higher charges for merchants. Competition does not constrain this. The only thing that does is merchants choosing not to offer card payments (unlikely) or regulation of the interchange fee (as we have in Australia).

And also, don't be too sad for the retailers. They built those fees into prices and competition between them means that those credit card costs are spread across all consumers. What that means is that when you choose a credit card purchase you are imposing costs on your fellow consumers that don't have or use credit cards.

According to many IO analyses (most notably, Rochet and Tirole), the benefits do not likely exceed the costs. And the costs manifest themselves in card issuers sending out more than a billion card solicitations each year. Not a paragon of efficiency.



If businesses differentially priced based on use of a card vs. cash (as my mechanic does) I would gladly carry more cash with me. If I believe Dave Ramsey (and I'm inclined to) I would probably spend less because it hurts more to lay a Benjamin on the counter than it does to lay down my plastic. Even if it's a debit card and comes right out of my checking account.


I always assumed my Discover card had a higher fee, because some places only take Visa & MC. Glad to see that is indeed the case.

As a consumer, I almost always use my credit card. The cost of the transaction fees is somehow factored into the price, so I'm being overcharged if I don't use my card. Plus, I get rewards points from my credit card.

I'm amazed that a few places like Wal-Mart actually let me get "cash back" with a credit card transaction, i.e. I buy $10 dollars worth of stuff, they charge the credit card $110 and give me $100 back. They are paying the transaction fee on money that didn't even go to a sale! This has replaced the ATM for me, because I like getting rewards points for withdrawing money. (Besides, I always pay my statement, so I never get charged interest.)

Justin James

Wow, am I the only person who remembers, not too long ago, when gas stations charged different (higher) prices for credit card purchases? Does anyone else remember when most stores would not allow credit card purchases for less than $10?

The fact that so much of commerce is done via credit card has put a 1.5% - 3% or so drain on our economy, and that money is essentially "friction" that generates *nothing* productive what-so-ever. If the government raised your taxes 1.5% - 3% to cover a "convenience fee", you would howl. But when retailers raise their prices the same amount to compensate for the "MasterCard tax", we seem to not mind it.

Also, if you think the "solution" is to stop using your debit card as "credit" and just punch your PIN in... WRONG WRONG WRONG! Many banks charge a fee for using an ATM that is not in their network (in addition to the fee that the ATM owner charges!). These fees are a relatively new invention, and existing accounts are "grandfathers" against the fee, which is why most people are not aware of it. My bank (Wachovia) charges me $2 for using an out-of-network ATM. So for me to draw $20 from a BoA ATM costs me $4... $2 from BoA and $2 from Wachovia. Here's the sick thing, though. When I punch my PIN into the card reader at the store, guess what? It's considered a ATM withdrawl! So by *not* passing the 1.5% - 3% fee onto the retailer, I am on the hook for $2! Needless to say, that encourages me to use my card as "credit" (and accumulate miles while I am at it).

As a personal policy, I always carry about $20 cash on me. Any purchase less than $10, I use cash for. While the net effect on me, the customer is the same, why not give the retailer an extra 1.5% - 3% "present"?




>>. I presume that the issuing banks can choose their own fees (within reason)<< By "issuing banks," you mean the bank that issues the credit card to the cardholder? Do the merchants deal with the issuing banks? I assume they deal with MasterCard, Visa, American Express and Discover. A merchant doesn't "take" of "not take" Capital One cards. It takes, or doesn't take, Amercan Express. I assumed that that the banks make money on the interest and/or other fees the customer pays, and the credit card companies collect the fees that the merchants pay.