The Credit Series - Part I

In 1958, Bank of America carried out an experiment in the tranquil hills of Fresno, California. An experiment that would forever alter the course of capitalism. The economic ripple effects from this would reshape global payment forever.

The bank sent 60,000 credit cards to the residents of Fresno. The cards were unique and first of their kind as they offered a revolving line of credit that could be used anywhere. The cards gained massive popularity as the bank decided to expand the program to a national level.

Today, the United States is home to roughly 1 billion credit cards, with over 3 billion in circulation globally. The credit card industry has swelled into a staggering $2.4 trillion behemoth. Credit card issuers seductively paint them as a magic carpet ride to a life brimming with luxury and dreams. Yet, in the hands of a reckless user, it could turn into a relentless nightmare.

Here are some credit card numbers we know today

• Worldwide, more than 3 billion credit cards buzz with activity.

• The top 4 credit card companies in the United States raked in a whopping $470 billion in revenue.

• Credit card companies paid $149.6 billion in rewards to users in 2022 in the form of cashback, travel points, and merchandise.

• The cumulative credit card debt in the United States ballooned to $1 trillion in 2022.

• The average interest rate levied on credit card balances in the United States exceeded 20% in 2022.

• VisaNet, the globe's largest credit card processing network owned by Visa, can process an astonishing 65,000 transaction messages every second. In a mere two seconds, it could process all transactions occurring in the US.

But what is a credit card?

Credit, stemming from the Latin word 'Credere' meaning 'trust', encapsulates the essence of credit cards. Credit card companies use credit scores to decide who to lend money to. Whenever a user swipes their credit card at a merchant, they are essentially being loaned the charged amount in the hope that they will pay it back to the credit card issuer within the specified timeframe. If a user is unable to make payments on time, the credit card companies can charge a user interest.

There are 4 types of credit card customers -

1. Transactors: These are the ideal type of credit card users. Transactors leverage their credit cards as cash dispensing machines, using them for virtually every purchase. They always clear their dues in full at the end of the billing cycle, often boasting the highest credit scores, garnering attractive rewards, and maintaining healthy financial standing.

2. Revolvers: This is the type of user you should steer clear of becoming. Revolvers carry over their statement balance to the next billing cycle, thus incurring interest charges. This interest can skyrocket to as high as 28% in certain cases, turning into massive debt for some.

3. Nonusers: These are individuals who shun the use of credit cards entirely. Even as we head into 2023, a considerable number of people, predominantly baby boomers, avoid using credit cards for a variety of reasons. However, being a non-user doesn't necessarily mean saving money. In fact, non-users often end up paying more without reaping any benefits.

4. Hackers (Superusers): They are the type of users that the industry absolutely dislikes. A credit card hacker. Hackers know the rules of the credit game and they apply it against the credit card companies to extract maximum benefits for themselves out of a given credit card without ever paying the fees and interest. If you are a credit card transactor and manage your debt and finances well, over time you are more likely to be a hacker. It can take years to understand the games the credit card company is playing with you and to develop the understanding to beat them in their game.

How Credit Card Companies Turn a Profit

Credit card company ability to turn a dime centers largely on one fundamental aspect - interest rates charged to revolvers. According to the Federal Reserve, a staggering 80% of a credit card company's income originates from interest. This hefty slice of the pie is due to the traditionally high-interest rates on credit cards, averaging around 16% in the U.S., with some even peaking at 28%.

Additionally, fees play a crucial role in their revenue streams. This takes several forms:

1. Interchange Fees: Credit companies earn a bounty for every transaction processed. Visa, for example, charges merchants around 2% per transaction. This fact is why many merchants are wary of American Express - their swipe fees have a reputation for being quite steep.

2. Annual Fees: Some credit cards carry an annual fee, which issuers often waive during the first year to attract customers.

3. Foreign Transaction Fees: If you use your card for a purchase in a foreign currency, a foreign transaction fee may apply. Typically, this fee is a percentage of the purchase amount.

4. Late Payment Fees: Late payments come with their own penalties. A fee, usually a percentage of the owed amount, is charged for late payments.

Apart from these direct monetary means, companies harvest vast amounts of user data via geolocation tagging, swipe patterns, and shopping habits. They sell this data treasure trove to market research and data broker companies for a hefty sum.

Staying Debt-Free in the Credit Card Game

The golden rule of avoiding credit card debt? Budget and monitor your spending. Forge your credit card into a single-edged sword, not double.

Here are some tried and tested strategies:

1. Try to make purchases you can fully cover each month. Attempt to treat your credit card like a debit card. If your checking/savings account has $10,000, never let your total credit limit exceed this. This practice ensures you always have ample funds for payments.

2. Resist the temptation of cash advances and balance transfers unless absolutely necessary. Credit card companies typically levy heavy fees for these transactions.

3. Choose a credit card that caters to your needs. For a typical couple, just two cards - one for general shopping (like Discover Cashback) and one with travel perks (such as the Chase Sapphire Preferred or Reserve) should suffice.

4. Keep a hawk's eye on your credit. Regularly log into your account to check for recurring charges, interest, due dates, and credit scores.

5. Avoid the allure of excessive credit. More cards mean more spending to control, more fees, and interest payments to track.

6. Make it a habit to pay your statement balance in full. Those who do enjoy great credit histories and avoid sky-high interest and fees.

7. At year-end, analyze your spending report. Many companies offer free annual spending reports, which can be invaluable in dissecting your consumption habits.

Remember, the path to wealth is paved with wise debt management. Spend prudently, monitor your credit history, and try to not accumulate late fees or interest on your cards.

This is a peek into credit card companies and smart usage practices is the first part of our multi-part series on credit cards. Stay tuned as we explore the best credit cards on the market, how to free yourself from credit card debt, ways to boost your credit scores, and case studies showcasing various debt levels.

The information provided here is for entertainment purposes only, does not constitute financial advice, and should not be used for making investment decisions; you should consult with a professional advisor for such advice tailored to your specific circumstances.