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A Beginner’s Guide To Interchange Fees

Bailey Jarrell

With so much industry lingo around credit card processing, it can be difficult to pinpoint the important terms and procedures that relate to you as a business owner. Accurately reading your processing statement is complicated, especially if you don’t understand the elusive language revolving around the numbers. One of the terms often used by industry experts is interchange fees (also known as interchange reimbursement fees.)

What are interchange fees and why are they important for you to understand? These fees are often the largest expense you’ll dish out whenever your customer swipes their card, so we think it’s only beneficial to educate you on this topic. While interchange fees are determined by many different variables which are largely out of your control, there is still great power in knowing where your payments provider might be hiding them and how you can choose the processing plan that makes the most sense for your company.

What are Interchange Fees?

From the time a customer swipes their card, there are many different entities involved in making sure that their money lands in your bank account successfully. For any given transaction, the money can pass through anywhere from 3-5 banks or other businesses before it reaches your pocket. All of these entities play a specific role, and they each charge their own percentage in exchange for their services.

Interchange fees are collected first and foremost by the credit card company that provides your customers’ cards. Visa, Mastercard, Discover, and American Express are the major associations that take over most of the credit card industry in the United States. Interchange fees are required by the issuing bank, which is another industry term meaning the financial institution that sponsors your customers’ credit card. Still not sure where issuing banks come into the picture? Not to worry, we’ve got you covered.

Issuing Banks

The previously mentioned credit card associations (Visa, Mastercard, Discover, and American Express) all publish their own list of interchange rates based on every type of transaction and card type possible. The main difference between these big players is both Discover and American Express operate as both the issuing banks and the sponsoring credit card associations. In contrast, Visa and Mastercard simply sponsor credit cards provided by other banks, which is why they have cards all around town with their logo on it. The issuing bank is the establishment that provides credit to consumers and takes on the risk involved. Issuing banks end up charging almost all of the interchange fees related to a transaction, and that’s why it’s helpful to know their part in the puzzle.

Network Fees

Let’s circle back around to Visa and Mastercard for a second. As previously stated, these companies are not issuing banks and have to work with other banks to cover the risk and logistics involved with issuing credit to consumers. As a result, these companies charge a separate network fee per transaction, usually around 0.05% per swipe. It’s important to note that network fees are completely separate from the interchange rate and add to the cost you end up paying each month. For example, if you run a $100 transaction the network fee at a 0.05% rate would only be $0.05. Not a big deal, right? It doesn’t sound like alike, but there are billions of Visa and Mastercard transactions being processed annually. Those seemingly small fees add up. So much that in 2017, Mastercard on its own brought in over $6.6 billion in net revenue.

What Affects Interchange Rates?

So many variables impact interchange rates, and there are hundreds of possible rates you might have to pay. While there are far too many variations to list, here is a sample of interchange rates you might come across:

With hundreds of variables per transaction, this table only scratches the surface of interchange rates. There are, however, a few averages across the industry that may help you gauge interchange fees based on card type. The average interchange rate for debit cards in the U.S. is 0.3% and the average for credit cards is approximately 1.8%. We don’t suggest going off of these rates, though, as they can fluctuate based on a number of factors, largely due to the amount of risk taken by the issuing bank.

Let’s take a closer look at the factors impacting your transactions’ interchange rate:

Debit Versus Credit Cards

Credit cards will always have a higher interchange rate than debit (nearly six times higher,) simply because there is a lot more risk involved. Transactions on a debit card are a lot easier and safer for issuing banks to approve because the funds come directly out of the customer’s bank account. Approving the transaction is solely based on whether the customer has sufficient funds in their account to pull from. Meanwhile, credit card transactions put a lot of risk on the issuing bank since they are covering the initial cost of the purchase while extending credit to the consumer. The issuing bank relies on the customer to pay them back at a later date, which requires them to take extra precautions in order to prevent fraudulent transactions.

Card-Present Versus Card-Not Present

What is the difference between card-present and card-not-present transactions? Exactly how it sounds. If the customer doesn’t present the merchant (you) with a physical credit or debit card, you would have to key in the card information manually. eCommerce and MOTO (mail order telephone order) transactions always use a card-not-present method, while some retail settings also run transactions this way if the terminal can’t read your customer’s card. Most of these cases occur when the magstripe wears down over time. Card-not-present transactions always pose a greater risk for the issuing bank, as they have no way of proving who the card belongs to. A brilliant solution to this issue was the introduction of EMV cards, which contain embedded chips to be dipped into the card reader. These chips have revolutionized the credit card industry and greatly reduce the risk involved with weathered magstripes.

Transaction Categories

Something to take note of is that credit card associations separate their interchange fees based on the type of business running the transactions (i.e., restaurants, gas stations, general merchandise, etc.). We suggest doing some additional research to understand the specific interchange fees that apply to your business category.

Rewards Cards

Everyone loves earning flyer miles, cash back, or other bonus perks for shopping with their rewards card. These types of credit cards have become widely popular over recent years, but there’s a catch. Someone has to pay for all of those free flights and other perks, and that person is you. Interchange fees cover the cost of providing these benefits to customers, which is why the fees are so much higher for processing rewards cards than other card types. You’ll especially see a major difference in price if you’re currently on a tiered pricing structure. Tiered pricing bumps the transaction on a rewards card to nonqualified, often making them 2-3 times more expensive to process than qualified transactions.

Card Brands

Not only does card type impact interchange fees, but also the credit card brand. As mentioned earlier, each credit card association determines its own fee structure, which changes your monthly bill depending on which card brands your customers want to use. American Express has been widely accused of being one of the most expensive card types in the industry, but its recently introduced OptBlue program has made it much easier for small businesses to accept this payment type. If you’re not sure why your processing bill fluctuates so much every month, keep in mind that it’s probably due to the various card types your customers are using.

Address Verification Services (AVS)

In order to run card-not-present transactions, you must verify that the address provided at check out is consistent with the customer’s billing address on record with the issuing bank. In order to do this, your processor will prompt the Address Verification Service to verify that information. There is usually a fee associated with using AVS (anywhere between $0.05 to $0.25 per transaction), however using AVS reduces the interchange cost which generally offsets the additional fee. Companies that primarily use eCommerce, Mail Order or Telephone Order and need to integrate AVS into their business model should further discuss the topic with their processing company.

While these are primarily the most significant facets influencing interchange rates, there are other smaller factors that can affect your monthly fees. If you want to do your own research on the topic, we suggest starting with the following documents: Visa USA Interchange Reimbursement Fees and the Mastercard 2018–2019 U.S. Region Interchange Programs and Rates. Keep in mind that many credit card associations update their documents twice a year (in April and October) and you can find their most recent information with a quick Google search.

Processors and Interchange Fees

Processing companies use many different methods of charging their merchants in order to cover the costs of paying interchange fees and of doing business. Before breaking down the various processing plans it’s important to point out that processors sometimes refer to their interchange fees as the wholesale rate.

When choosing your processing company, you will see one of two different approaches for processing rate plans known as either pass-through or blended pricing.

Interchange-plus and subscription pricing models use the pass-through approach which separates the interchange and the markup costs into two different numbers. This method will always allow you to know how much money your processor is taking from a transaction, even if you don’t already know the interchange rate. Even though your monthly statement will look different depending on the variables that impact interchange rates, you are more likely to save a lot of money on this model. The blended approach, mostly used in a flat-rate or tiered pricing plan, combines the interchange fee with the processor’s markup into one overall number.

This means you will usually have no insight into how much the company is making off of your transactions versus what is being paid to the issuing bank. Many people gravitate toward these models because it simplifies the numbers and makes the processing costs more predictable across transaction types. But you end up paying a lot more on your processing if you go this route.

Your Processing Plan Options

Let’s break down the different processing rate plans so you can see how each method handles interchange and markup costs:

1) Flat-Rate Pricing

Flat-Rate pricing models simplify your cost structure by charging one rate for every transaction. Your monthly processing statements are predictable and easier to read on this model, but it also blends the interchange fee and the markup into a single rate, making it impossible to know how much margin the processing company is making off of your business.

Square is the most popular payments processing company that uses flat-rate pricing, and they attract a lot of customers due to their simple structure and on-boarding process. However, take note of the fact that you will be charged the same rate for both debit and credit cards, which means you will pay a lot more than necessary for low-risk transactions. In addition, companies built on the flat-rate model don’t usually charge other fees for their services, meaning they will likely charge more overall to cover those operating expenses.

It’s important to mention that flat-rate processing is a reasonable pricing model for small businesses with low processing volumes. If you’re doing $5,000 or less in business each month, this may be the best route for you. But as your business grows, you will want to look into alternative pricing methods.

2) Tiered Pricing

Tiered pricing is the worst alternative pricing model in the industry. Processing rates are simplified and more predictable, like flat-rate, but instead of paying a single flat rate, your transactions will be categorized as either qualified or non-qualified (some companies also use a mid-qualified category.) This model is strategically structured to guarantee that the processing company makes a profit regardless of the actual interchange rate, so you’ll often end up paying a hefty markup fee.

On top of that, the fees are blended into one number on your statement, so you will never be able to distinguish how much of a cut the processor is taking on your transactions. They will also end up charging you all the extra fees that are eliminated in flat-rate pricing, such as account fees, gateway fees, PCI compliance fees, and other fees. We strongly advise avoiding tiered pricing plans, as they are designed to maximize your processor’s profits on your dime.

3) Interchange-Plus Pricing

Circling back to your business’ processing volume, if you are currently running at least $5,000 in transactions per month, interchange-plus pricing plans are the most affordable and transparent model for you. This pricing structure implies that interchange fees will be passed through at cost, and your processor’s markup will be fully transparent. Although you will still have to pay additional monthly and annual fees, the overall savings you will receive on your processing will more than counteract the cost as long as your processing volume is high enough to cover the margin. You will also see great savings on debit card transactions since the cost is based on the interchange rate.

4) Subscription Pricing

Subscription-based pricing, commonly referred to as membership pricing, is similar to interchange-plus by separating the processor’s markup from the interchange rate. The difference is that your processor charges a single monthly subscription fee rather than a handful of separate merchant account fees. This pricing model works best for established businesses with high monthly processing volumes and we suggest taking a deeper dive into your business’ costs and volume before choosing this pricing plan.

Here’s a high-level snapshot of how the various processing rate plans work with interchange fees:

Pricing Model Example

Below is a sample of possible rate quotes you might come across, what type of pricing plan they implement, and whether the interchange rate is included in the rate quote:

Sample Processing Rates

Based on this article alone, we know there’s a lot of information to take in around the topic of payments processing. As a business owner, no one expects you to become an expert in this field, but we hope you at least have a better foundation for the basics of credit card processing and how it impacts your company’s growth. If you want to stay informed on industry news, subscribe to our blog and we’ll work hard to give you the best educational pieces and learning opportunities, not to mention some major inspiration for your journey as a business owner. From where we stand, we’re in this together, and we are committed to being your advocates, listening ear, and growth champions in the ever-evolving world of payments processing.

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