How Visa, MasterCard Earn Cash (and Why You Should Care)

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Colorful stack of credit cards and shopping gift cards.  Macro with extremely shallow dof.
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Quick quiz: How much does the average American Visa (V) or MasterCard (MA) holder pay directly in fees to those two credit card behemoths every month?

Technically, nothing. But of course, since neither is a charity, they rake in the cash regardless, and cardholders are affected by that process. Here's how they get their money.

Neither a Borrower nor a Lender Be

Both Visa and MasterCard operate immense payment networks. They are, in every sense of the word, the middlemen. They don't extend credit to a cardholder (in the case of a credit card), and they don't send or receive payments from their own resources. They make money by facilitating transactions made with their products.

This is the big difference between Visa and MasterCard and more exclusive brands such as American Express (AXP) and Discover Financial Services' (DFS) Discover. Those two typically operate as card issuers and creditors at the same time. Most American Express holders borrow money from the company when they swipe its plastic.

With Visa or MasterCard, here's how the process goes. A cardholder pays for a good or service. That transaction is transmitted to the merchant's bank (the "acquirer" in industry parlance), which relays it through Visa or MasterCard's network to the financial institution that issued the purchaser's card (the "issuer"). If the cardholder has sufficient credit for the purchase (with credit cards) or the cardholder has enough money in their account (with debit/gift cards), the issuer authorizes the transaction. The acquirer then makes the final authorization.

Fee for All

Of course, all this back-and-forth generates fees.
  • Merchant discount fee. Depending on the type of Visa or MasterCard used (credit, debit, gift card, etc.), a chunk of the total -- generally 1 percent to 3 percent -- will be deducted from the purchase by the acquirer. The merchant gets the remainder -- the purchase total minus the discount fee. The discount fee is divided among the parties involved behind the scenes. The biggest division is the interchange fee, or the monies collected by the issuer for its part in the transaction. These rates are set by Visa and MasterCard, even though neither company receives them directly.
  • Processor and acquirer fee. The processor provides the technology -- cash register, point-of-sale terminal -- used for the sale. The acquirer takes its cut here. These fees vary but typically are small (measured in tenths of a percentage point).
  • Credit card network fees. Here's where Visa and MasterCard start getting paid. They grab fees from the acquirer and the processor. Since those two participants get a small part of the total transaction, the card giants get an even tinier piece. However, when we're talking about billions of purchases, those slivers really add up. In fiscal 2013, Visa's top line totaled $11.8 billion, a 13 percent year-over-year improvement. Net profit was just under $5 billion, a whopping 132 percent higher than in 2012. MasterCard's 2013 revenue was $8.3 billion, while net came in at $3.1 billion. Both figures were 13 percent higher than in the previous year.
Irate About Interchange

Visa and MasterCard have to set their interchange rates high enough to entice banks to issue their cards. But are they too high?

Last year, in the culmination of a long-running dispute, a $5.7 billion class action settlement was approved between a gaggle of merchants and business trade groups and Visa and MasterCard (plus a host of issuers), over what the former considered to be excessive interchange fees.

Already forced to slice such charges for debit cards by the 2010 Dodd-Frank financial legislation, Visa and MasterCard assented to temporarily reducing fees on credit card transactions, too.

But a bunch of dissenting class members, including Target (TGT) and Walmart (WMT), have backed out of the settlement, choosing to pursue their own courses of action.

Advocates for lower card fees argue that the current structure forces merchants to pass along those costs to consumers. Consumers, in turn, buy less and pay more and contribute to those fat revenue and profit figures for Visa and MasterCard. The National Retail Federation claims that payment card fees cost the average American household $400 per year.

So although we as consumers don't technically put money in the hands of those two giants, we still end up paying them. Considering how many cards we collectively own and how often we use them, that adds up to more than a pretty penny.

Motley Fool contributor Eric Volkman has no position in any stocks mentioned. The Motley Fool recommends American Express, MasterCard and Visa, and owns shares of Discover Financial Services, MasterCard and Visa.

How Visa, MasterCard Earn Cash (and Why You Should Care)
Most of us spend a ton of time researching our options when we first sign up for a plan or policy, then forget all about it and make monthly payments like a robot. But this can cost you.

If you've been on the same cell phone plan for a while, or you haven't looked at the terms of your insurance policies (home, life, auto) since you got them, it's time to do a review. Your circumstances may have changed, and new plans or deductions may have come out since you first signed up. Call up customer service (or your agent) and have them walk you through your options if you're having trouble comparing things on your own.
One of the biggest budget sucks is our own forgetfulness. We miss payments and incur late fees because we've misplaced our statement or didn't manage to get our mail out in time. We fail to save as much as we'd like because we just never remember to do it.

The easiest way to save yourself some money (and hassle and stress) is to set it and forget it. Sign up for auto-pay so your monthly bills are automatically deducted from your checking account. Have a certain amount automatically transferred each month from your checking to your savings account. Remove the human error factor, and your budget will be better for it.
We charge so much nowadays -- whether on credit cards or debit cards -- that it's easy to spend a lot of money without really registering it. When you have a set amount of bills in your wallet, however, it's extremely easy to see how much you've spent so far this month and how much is left.

Take those budget categories of yours -- groceries, entertainment, etc. -- and turn them into real, physical envelopes. At the beginning of each month, put that month's allotment of cash into each envelope. When you're running low, you'll know you need to be careful with your purchases. When you're out, you're done spending on that category till next month.
If you're prone to impulse purchases, imposing a waiting period on yourself is an easy way to break the cycle.

For large purchases, a 30-day waiting list is best. Write down the item that's calling to you, then wait 30 days before allowing yourself to buy it. You may realize in that time that you don't need it after all. Or you may forget why it called to you in the first place.

For smaller impulse buys, like that fancy new product you spotted in the grocery aisle, follow a 10-second rule. Before the item can go into your cart, spend 10 full seconds asking yourself if you really need it and how you will use it. Simply analyzing why you're getting something can disrupt the siren call of a product.
It's all too easy to blow $5, $10, even $20 on something, whether it's an extra meal out or a coffee on the run. In the grand scheme of things, it "doesn't seem like much" to us. But if you start thinking of your money in terms of the time it took you to earn that money, suddenly you find yourself evaluating your spending choices a little closer.

Figure out what you make per hour if you're salaried (if you're hourly, this will be easy). Let's say you make $15 per hour. For every $15 you spend, you'll have to spend another hour of your time at work to pay for that item. A coffee a day for a week can cost you an hour or two. And bigger items, like that flat screen TV you're eyeing? You get the drift. Framing purchases in light of time spent can help you make sure something is worth it.
In the end, a budget is simply a means of making sure your money is working for you. It allows you to see how much you're brining in and allocate it towards the things that are most important to you. If you can hold those bigger goals in mind, everyday budgeting becomes easier.

If you're wondering whether or not to buy something, ask yourself if that money would be better spent towards your big goal. Put a visual reminder in your wallet to keep you on task-like a photo of a sandy beach if you're trying to save up money for a trip. Viewing your budget in terms of what it will allow you accomplish-not the things it won't allow you to buy, can revolutionize your spending.
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