What Are Interchange Fees and How Are They Calculated?

Interchange fees are charges credit card networks impose on businesses that accept credit card payments. Your business will pay the interchange fee alongside a merchant service provider fee and other charges a network may apply when accepting payments.  Credit card networks produce these interchange fees to ensure their networks and the banks that issue their cards are adequately reimbursed. The effort also covers possible risks of chargebacks, fraud, and other concerns. The work is to help customers feel protected and secure from possible unexpected losses when using credit cards.

In this blog, we’ll analyze interchange fees, how they function, and how to calculate them. Finally, we’ll discuss strategies to reduce interchange fees and increase profit margins. So, keep reading for the full details.

What Are Interchange Fees?

An interchange fee is a charge that merchants incur when processing credit or debit card payments. Banks impose these fees to offset the costs associated with payment processing, which includes accepting and authorizing payments. Any merchant that accepts card payments, knowingly or unknowingly, pays an interchange fee. This transaction fee applies to both online and offline transactions.

Interchange fees typically range from $0.20 to $0.65 per transaction, but this amount can vary depending on the type of card used and whether the transaction falls under the interchange fee standard. This standard regulates fees to prevent excessive charges, but exceptions exist for debit card issuers with assets under $10 billion.

The interchange fee consists of three components:

• Acquirer: The merchant’s bank or payment facilitator.
• Card Issuer: The customer’s credit card company or bank.
• Card Network: The brand of the card, such as Mastercard, Visa, AMEX, or Discover.

How Does the Interchange Fee Work?

The interchange fee is planned through a few steps:

• A business will process a credit card transaction.
• The acquiring bank will calculate an interchange fee. The acquiring bank is the merchant’s bank that provides access to the card network. The fee is calculated using many parameters surrounding the deal.
• The acquiring bank will pay the interchange fee to the card-issuing bank, which is the group that provides the card the customer uses in the payment.

A merchant service provider facilitates the interchange fee process. It reviews the transaction fee and adds a proper merchant fee alongside the initial charge.

Pricing Structures Offered by Processors

Processors offer different pricing structures, allowing organizations to choose the most suitable option for their needs. These fee structures include:

• Interchange Plus Pricing:

This widely used structure provides a transparent view of the interchange fee, assessment, and processor markup. Many organizations need help getting an overall view of their credit card processing fees, but Interchange Plus Pricing addresses this issue. Here, the card network imposes a charge on top of the interchange rate. This structure can benefit large organizations with substantial sales volumes, as they can negotiate the processor markup rate based on transaction volume.

• Flat-Rate Fee Structure

In some cases, you may encounter a flat-rate fee structure, a common arrangement for many businesses. Aggregators like PayPal, Stripe, and Square typically charge a flat fee, such as 2.95%, meaning you pay the same fee regardless of the type of card used. Additional fees may also apply.

• Tiered Pricing:

In this model, the processor categorizes transactions into different tiers based on factors like the type of card used, transaction type, and sales category. Each tier has a designated price fee. This model makes it difficult for organizations to gauge the interchange fee and markup, leading to potential overpayment compared to the interchange rate. However, organizations with large sales volumes primarily within a single tier can sometimes negotiate lower tier fees.

• Blended Pricing:

This structure combines a processing fee with a fixed markup fee that remains constant regardless of the processing fee. This model offers a simplified approach, but organizations cannot get a comprehensive view of costs, particularly regarding the interchange fee and assessments. Blended Pricing can be suitable for smaller businesses just starting to accept credit card payments, though it may sometimes be more expensive than the interchange rate.

How Is the Interchange Fee Calculated?

You can calculate the interchange fee for a transaction by reviewing a few terms surrounding the deal. The interchange rate is calculated over these factors:

1. How the card is processed

How a credit card is used influences the interchange fee, sometimes referred to as the “presentment type.”

For instance, you will experience a lower rate if the card is present. A card-not-present transaction has a higher rate due to the added risk of someone impersonating the actual cardholder. In the US, at the time this article was written, credit card Card-Present (CP) transactions can have fees ranging from 1.50% to 2.50% of the transaction amount, while Card-Not-Present (CNP) transactions generally have higher rates, ranging from 1.80% to 3.50%.

This is how, in some situations, the way that payment is processed can lead to reduced interchange rates. For example, recurring billing offers lower rates than regular e-commerce transactions, likely because the risk associated with recurring transactions is generally lower than for new one-off transactions.

2. Data Submitted with the Exchange

The processing details of each transaction influence the interchange fee. If you provide extra details on a transaction, such as a CVV entry, AVS data, and other factors on a sale, you could get a lower rate.

Transactions utilizing secure processing methods, such as EMV chip cards or tokenization, may qualify for lower fees, while card-not-present transactions (like online or phone orders) typically incur higher fees due to increased fraud risk. This is because you will show that your transaction is legitimate, thus reducing your overall rate. Additionally, quickly settled transactions may have reduced fees compared to delayed ones.

3. Merchant category code

A distinct code represents every business. The code will vary by industry and the type of product sold. Each code features a distinct interchange rate. For instance, high-risk businesses, such as airlines or online merchants, may face higher fees, while categories like charities or travel agents might benefit from reduced fees.

4. Card Network:

The card network is a key factor in determining the interchange fee, as each network sets its rates that form the baseline for fees charged. The four major card networks are Visa, Mastercard, American Express, and Discover.

These networks typically review their rates twice yearly, updating them in April and October. Visa and Mastercard publish their rates publicly, while American Express and Discover do not. In general, Visa and Mastercard have lower interchange fees than American Express.

While various factors contribute to the final fee, the average interchange rates for each network are as follows:

• Discover: 1.55% to 2.45%
• AMEX: 1.80% to 3.25%
• Visa: 1.30% to 2.60%
• Mastercard: 1.45% to 2.90%

5. Type of Card

Interchange fees can vary depending on the customer’s card type. Credit and deferred debit cards incur higher interchange fees than debit and prepaid cards due to the higher risk associated with these card types. Debit cards also have lower interchange rates because they facilitate direct payments from a bank account.

Additionally, credit cards issued to businesses generally have higher interchange rates than those for individuals. Cards offering rewards programs also attract higher interchange fees to cover the costs of the benefits provided to customers, and card networks need to cover the costs associated with these schemes.

6. Type of Card Holder:

The cardholder’s status also affects the interchange fee. Commercial or premium cards, which offer additional rewards or benefits, generally incur higher fees, as that entity is more likely to spend extra and have multiple copies of the same card. An individual won’t have as high of a rate as that person has more control over how one’s card is being used.

Due to their lower risk, debit cards typically have lower fees than credit cards, and international transactions tend to result in higher interchange fees than domestic ones.

Every card network has unique terms for calculating an interchange rate. Check with the card networks you support to see what terms they use and if they can provide specifics for your rate. You can search on Google to find the local Visa or Mastercard website for your region. From there, you should be able to locate the official interchange rates for your country.

Who Pays Interchange Fees?

Merchants pay interchange fees, albeit indirectly. They pay a fee to their credit card processor to accept credit cards, and this fee can follow various pricing structures:

• Flat Rate Pricing
• Bundled or Tiered Pricing
• Recurring or Membership Pricing
• ERR or BackBill Pricing
• Interchange Plus Pricing

All of these models incorporate interchange fees.

Interchange Plus pricing is the most transparent option for merchants, as it separates the interchange rate from the payment processor’s markup, making costs clearer. Other pricing structures generally involve higher markups. In practice, the acquiring bank pays the issuing bank the interchange fee, and the merchant reimburses the acquiring bank.

How Can These Fees Influence Your Business?

Card networks always argue that credit card interchange fees ensure businesses bear a fair share of processing costs. They explain that these fees also compensate issuers for lost interest resulting from cardholders’ grace periods.

However, an increasing number of merchants disagree.

Interchange fees will make it harder to keep your cash flow in check. You’re not collecting everything in a card transaction like you would through a cash or check payment.

For example, you might process a transaction worth $200. However, the interchange rate is 2.3% plus 10 cents. You would spend $4.70 in interchange fees here, meaning you would get $195.30 out of that $200 order.

The interchange fee also pairs with a merchant fee. A merchant service provider that processes your transactions will add a fee on top of the interchange rate. In this example, the MSP could have a rate of 0.5% plus 5 cents, increasing the total to 2.8% plus 15 cents. At this point, the $200 transaction will return $194.25, with the remaining $5.75 being split among the card-issuing bank, the card network, and the MSP.

Some view interchange fees as a financial incentive provided to issuing banks by card networks as a “compensation” for issuing payment cards and managing cardholders’ accounts. Many merchants advocate for a cap on these fees. They argue that technological advancements have made credit card processing significantly easier over the past decade, yet interchange fees have doubled. Others go even further, suggesting that card networks should bear these costs, as they benefit from banks issuing branded payment cards.

Issuers and card networks counter that interchange fees only reduce merchants’ profits by a small percentage from each transaction. Yet, this seemingly small amount can be substantial for industries with narrow profit margins, such as restaurants and gas stations.

Interchange fees also tie into chargeback costs. If a chargeback occurs, merchants lose the interchange fee from the initial transaction. Furthermore, accumulating too many chargebacks may classify a business as “high risk,” resulting in a significantly higher interchange rate. In extreme cases, this can even lead to account termination.

Can You Get a Better Rate?

While you can negotiate better merchant fees with your service provider, you cannot negotiate a better interchange fee with a card network. You’ll have to cover the rate that the network provides you based on your business field and the card types you accept.

You can still get a better interchange rate for your transaction if you follow a few points to get your work ready. Here are a few tips to consider:

• Use the Address Verification Service when handling CNP transactions. You can confirm that the address on a card matches the address of the person purchasing something. The process reduces the risk of chargebacks and keeps your interchange rate down.
• Settle your transactions as soon as possible. At least three days after each sale is a good time to settle them to help you collect your funds and ensure the transactions are final.
• Get the merchandise out to your clients as soon as possible. Ship everything within seven days of authorizing the transactions. If you send out the merchandise soon enough, you will show you are prompt and direct when supporting your clients.
• When you settle the transactions, provide the order numbers and authorization IDs for each purchase.

While you cannot avoid interchange fees when accepting credit cards, you can reduce their impact on your business using the right tips. Be certain when handling cards that you recognize the unique terms you’re entering and that you have a plan for whatever works.

When finding your interchange fee, you can be certain that it will be accurate and reflective of how your business operates. Every industry has a unique interchange fee to cover, and each credit card network will plan different rates. Be aware of how you’re spending money on your interchange fees and that you have a merchant service provider that will help you handle the fees you are spending the right way. The work should ensure you have a plan for covering the costs.

Conclusion

Interchange fees play a pivotal role in the credit card payment ecosystem, impacting merchants and consumers. These fees, imposed by credit card networks, compensate for the costs associated with payment processing and cover potential risks like chargebacks and fraud. While merchants indirectly bear these fees, they can adopt strategies to mitigate their impact and improve profit margins.

Understanding how interchange fees are calculated is crucial for businesses. Factors such as transaction type, data submission, merchant category code, card network, type of card, and cardholder status influence the fee. Although merchants cannot negotiate interchange fees directly, they can negotiate better merchant fees with service providers and implement practices to optimize transaction processing and reduce fees.

Interchange Plus Pricing offers transparency, while other pricing structures may involve higher markups. However, regardless of the pricing model, interchange fees remain a significant consideration for businesses, particularly those with narrow profit margins. Effective interchange fee management involves carefully considering transaction processing practices and collaborating with merchant service providers to ensure costs are managed efficiently.

Frequently Asked Questions