Why do annual fees exist?

When looking for a no annual fee credit card, it’s a good idea to know why credit cards charge such fees and how to calculate whether accounts are really preferable with their removal.

For most credit cards, the annual fee is the smallest part of the bank’s revenue stream. Revenue is also collected through merchant fees, which are the fees charged to shops and service providers for processing transactions. Interest on credit cards is also a very large element in a credit card company’s revenue. In comparison, the annual fee is tiny.

The annual fee then isn’t charged to earn revenue, but to discourage people applying for credit cards they never use. If a card holder never uses the card, it won’t earn the bank any revenue through transaction charges or interest. However, these card holders cost the issuing bank money, through monitoring the account, keeping address records in order, and printing and mailing monthly statements. It also costs money to set up the card account in the first place.

If the credit card provider has a lot of these “free riders” carrying but not using their cards, administrative costs will increase. If these costs are sourced purely through interest rates, it tends to weigh most heavily on people who do use their credit cards rather than on those who don’t. As well, this bank’s interest rate will be higher than much of the competition.

Annual fees on credit cards, then, are a way of covering this administrative cost without having to raise the headline interest rates on the cards and the customers who use them.

Credit card companies have tried to get around this dilemma through inactivity charges, which instead of charging an annual fee will charge a fee only if the card is not sufficiently used in the month.

Of course, the card applicant has a different set of priorities to the card providers. No annual fee credit cards best suit individuals who don’t intend to use the card frequently or only in emergencies. Because no annual fee credit cards tend to be “no frills” cards, with higher interest rates and poor or no rewards schemes, they suit card holders who merely want access to credit without all the trimmings.

Why do banks offer no annual fee credit cards?

One of the questions that people can have about no annual fee credit cards is why do banks offer the cards?  After all, the annual fee is a part of what makes a card profitable.
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