When I was 22, I wondered how credit-card companies made money. I had two cards at the time. They were free to use. Every month I would buy things with the cards, and -- because I used auto-pay -- every month the balance would be deducted from my checking account. As far as I could tell, this was a free service. And if I decided not to pay my credit-card bills, and just go bankrupt, there was no way the card issuer would make money off of me. With things like cash back, it seemed like I was getting paid to use this card. What kind of business model pays people to use its product?
Ten years later, as I helped a friend figure out how to refinance his credit-card bills, I realized how the business model must work. Card issuers, mainly banks, profit by charging penalty fees when people pay off their credit-card balances late. Of course, that isn't the only way they make money -- they, along with MasterCard and Visa, also charge merchants fees to use the payment services, and they charge other fees for things like balance transfers. But a lot of their business model is just consumer lending -- which they do at rates of about 12 percent to 14 percent.