Kijanki,
Dan_ed is wrong in a way and right in a way. He is wrong because you only pay your $100 for the $100 item. He is right, however, because the merchant who accepts Amex or Visa/MC pays a portion of the bill to the CC provider (and Visa/MC). For every $100 charged, the vendor only receives $96.5-97.5 (roughly). Amex charges 3.5% to the merchant. Visa/MC is low-mid 2% area to up to 2.7% I think. Discover is a bit less. (Gasoline and groceries are lower for almost all card providers). 'Point' cards generally cost a little bit more to merchants (in order to give you the points) but merchants suck it up because they like customers who like to spend. 'Vanity' cards (Amazon, Borders, etc) cost a bit more to merchants than point cards do. Credit card issuers have a clause in their agreement with merchants which says that merchants are not allowed to charge credit card users more than they charge cash users. Most merchants have traditionally honored this because they don't want to get cut off by the credit card service. Therefore they charge cash users a higher price than they should (in terms of trying to make the same profit off the same item). If credit card issuers only took 0.1%, then all store prices would eventually drift down (believe it or not, they would). We all pay for all of us to us credit cards. Stories about how the consumer was wronged (defective item, etc) have a backstory to them too. Someone, whether it is the bank or the merchant, lost money on that sale. The time and money it takes to make it right cost more than the profit which would have been earned had it been a clean, good sale. Reputation risk is a further issue. All in all, though, we all pay a little bit extra just so banks/Amex/VISA/MC can clean up the messes which occur from time to time. CCs have traditionally been very good business for banks because of the economics described below.
That 2.5-3.5% allows the the credit card company to bill you at the end of the month and not charge anything if you pay it by a couple of weeks later. That 'float' is "free" to you for that. If you use your card at precisely the right time, you can avoid paying for close to two months. If not, the average carry will be about 6 weeks. Banks are effectively lending short-term money at 2.5-3.5% every 6 weeks, which annualized is 20-30%. Banks have to deal with fraud, and statements, and mailings, and advertising, and other stuff within that amount, but it's still good business. Fraud runs 1% or something like that. Then, if you keep a balance, they will lend to you at that "high" rate of 14%.
You may think that is a high rate. But when you forget to pay, they have to send you reminders, more reminders, phone calls, chase you down, etc. all of which costs you money. You'd be surprised how little that 14% is worth. If you carry a $1000 balance, it's $140 a year. If you don't pay it and instead let it build, that might be OK. Once. Then it happens again. They send an automated mailing to you - cost of $1. No biggie. They temporarily turn off the card. You call the CC company to get it turned back on, and you say you will promise to pay. They turn it on with a small limit and you don't pay, and now they have to chase you down with a real person. That costs real money because the collection agency gets a chunk of the money retrieved. If the bank thinks they can't get anything from you, after they have spent money to retrieve it from you, they can sell your unpaid debt to someone else (usually a company with the ability to act themselves as a collection agency), usually for pennies on the dollar. When they sell your $1600 debt (original $1000+$70 of interest after 6mos, and $500 the next month+the interest on that) for $100, they have to make up the other $1500+other costs incurred from all the other guys who are carrying balances. With 10 other guys, they get $140 per guy a year in interest, but they have costs of lending that $1000 x 11 guys in the first place, and there are costs of being in business. They probably break even on 5% default, but they make quite good money at 2-3%.
When default rates are quite low (like 2004-2007), banks don't need to charge much interest on the balance. They get lots of money from catching the 2-2.5% on the purchase itself and the 7% on the balance lots of people run is just for keeping people honest. When default rates climb to 5%, suddenly, they need to charge EVERYONE a great deal more just to avoid losing their shirts on the 5% defaulting (in an economic downturn, people don't default on $100, they default on $5,000 or $10,000, whereas the people who carry balances in an economic downturn but DON'T default do their damnedest to lower them in order to avoid paying lots of interest. They also spend less (meaning the bank gets fewer 2% fees on your purchases).
Then there is securitization. And if you want to really ugly, we can talk about talk about ABCPs, funding putbacks, and FAS 167 and consolidation accounting for VIEs.
Are CCs 'worth it'? Because buyers "pay" 2.5-3.5% extra on every purchase, they get convenience, protection, perks, etc. Merchants get convenience and safety (usually), and possible cost-savings (if the bulk of the sales are in large sums, most small merchants would rather pay the 2.5% away to VISA so they did not have to hire an extra security guard, hire someone to deliver the cash (Brinks?), pay extra liability insurance premium to one's insurer (because cash balances tend to attract thieves who might do physical damage to the store or bodily damage to employees), etc). And banks earn decent profits on this because 300 million Americans spend a LOT of money by credit card and every little expenditure has a 2.5-3.5% slice taken out of it to cover fraud, 6 weeks of interest, advertising costs, service costs, 'insurance', perks, points, money back, etc, oh... and profit for the issuing bank and card company.
Dan_ed is wrong in a way and right in a way. He is wrong because you only pay your $100 for the $100 item. He is right, however, because the merchant who accepts Amex or Visa/MC pays a portion of the bill to the CC provider (and Visa/MC). For every $100 charged, the vendor only receives $96.5-97.5 (roughly). Amex charges 3.5% to the merchant. Visa/MC is low-mid 2% area to up to 2.7% I think. Discover is a bit less. (Gasoline and groceries are lower for almost all card providers). 'Point' cards generally cost a little bit more to merchants (in order to give you the points) but merchants suck it up because they like customers who like to spend. 'Vanity' cards (Amazon, Borders, etc) cost a bit more to merchants than point cards do. Credit card issuers have a clause in their agreement with merchants which says that merchants are not allowed to charge credit card users more than they charge cash users. Most merchants have traditionally honored this because they don't want to get cut off by the credit card service. Therefore they charge cash users a higher price than they should (in terms of trying to make the same profit off the same item). If credit card issuers only took 0.1%, then all store prices would eventually drift down (believe it or not, they would). We all pay for all of us to us credit cards. Stories about how the consumer was wronged (defective item, etc) have a backstory to them too. Someone, whether it is the bank or the merchant, lost money on that sale. The time and money it takes to make it right cost more than the profit which would have been earned had it been a clean, good sale. Reputation risk is a further issue. All in all, though, we all pay a little bit extra just so banks/Amex/VISA/MC can clean up the messes which occur from time to time. CCs have traditionally been very good business for banks because of the economics described below.
That 2.5-3.5% allows the the credit card company to bill you at the end of the month and not charge anything if you pay it by a couple of weeks later. That 'float' is "free" to you for that. If you use your card at precisely the right time, you can avoid paying for close to two months. If not, the average carry will be about 6 weeks. Banks are effectively lending short-term money at 2.5-3.5% every 6 weeks, which annualized is 20-30%. Banks have to deal with fraud, and statements, and mailings, and advertising, and other stuff within that amount, but it's still good business. Fraud runs 1% or something like that. Then, if you keep a balance, they will lend to you at that "high" rate of 14%.
You may think that is a high rate. But when you forget to pay, they have to send you reminders, more reminders, phone calls, chase you down, etc. all of which costs you money. You'd be surprised how little that 14% is worth. If you carry a $1000 balance, it's $140 a year. If you don't pay it and instead let it build, that might be OK. Once. Then it happens again. They send an automated mailing to you - cost of $1. No biggie. They temporarily turn off the card. You call the CC company to get it turned back on, and you say you will promise to pay. They turn it on with a small limit and you don't pay, and now they have to chase you down with a real person. That costs real money because the collection agency gets a chunk of the money retrieved. If the bank thinks they can't get anything from you, after they have spent money to retrieve it from you, they can sell your unpaid debt to someone else (usually a company with the ability to act themselves as a collection agency), usually for pennies on the dollar. When they sell your $1600 debt (original $1000+$70 of interest after 6mos, and $500 the next month+the interest on that) for $100, they have to make up the other $1500+other costs incurred from all the other guys who are carrying balances. With 10 other guys, they get $140 per guy a year in interest, but they have costs of lending that $1000 x 11 guys in the first place, and there are costs of being in business. They probably break even on 5% default, but they make quite good money at 2-3%.
When default rates are quite low (like 2004-2007), banks don't need to charge much interest on the balance. They get lots of money from catching the 2-2.5% on the purchase itself and the 7% on the balance lots of people run is just for keeping people honest. When default rates climb to 5%, suddenly, they need to charge EVERYONE a great deal more just to avoid losing their shirts on the 5% defaulting (in an economic downturn, people don't default on $100, they default on $5,000 or $10,000, whereas the people who carry balances in an economic downturn but DON'T default do their damnedest to lower them in order to avoid paying lots of interest. They also spend less (meaning the bank gets fewer 2% fees on your purchases).
Then there is securitization. And if you want to really ugly, we can talk about talk about ABCPs, funding putbacks, and FAS 167 and consolidation accounting for VIEs.
Are CCs 'worth it'? Because buyers "pay" 2.5-3.5% extra on every purchase, they get convenience, protection, perks, etc. Merchants get convenience and safety (usually), and possible cost-savings (if the bulk of the sales are in large sums, most small merchants would rather pay the 2.5% away to VISA so they did not have to hire an extra security guard, hire someone to deliver the cash (Brinks?), pay extra liability insurance premium to one's insurer (because cash balances tend to attract thieves who might do physical damage to the store or bodily damage to employees), etc). And banks earn decent profits on this because 300 million Americans spend a LOT of money by credit card and every little expenditure has a 2.5-3.5% slice taken out of it to cover fraud, 6 weeks of interest, advertising costs, service costs, 'insurance', perks, points, money back, etc, oh... and profit for the issuing bank and card company.