What Are Basis Points & How Do You Calculate Them?
There’s a lot that goes into negotiating with a credit card processor. You need to make sure you’re getting favorable terms and the best rates. At Merchant Maverick, that means a month-to-month agreement (or at least one with no early termination fee), affordable hardware with no overpriced leases and an interchange-plus plan with a low markup.
Negotiating credit card processing rates can be a daunting prospect for a merchant. But the key to success is knowledge. You need to understand what a fair cost for processing it, especially in your particular industry and based on your business model. You also need to be able to take the rates you’re quoted and put them into real-world numbers. You’re probably familiar with percentages and percentage points already — but you might also hear the phrase basis points (BPS) in your negotiations. If you’re not a finance whiz, this might throw you off a bit.
The good news is basis points are really easy to understand. I’m here to explain them to you and show you how they affect your processing.
Warning: Math ahead! (Disclaimer: It’s not scary math.)
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What is a Basis Point Anyway?
A basis point is equal to one-hundredth of a percentage point: 0.01% (or 0.0001 written in decimal form). It’s the smallest unit of measurement used to describe interest rates, processing rates, and yields on financial products (such as bonds).
One hundred basis points equal 1%.
Yes, it’s that simple.
One of the arguments in favor of basis points is that it’s a way of removing ambiguity from statements involving numbers, and changes in numbers. Say for example, the standard yield rate is 8.5% and it increases 3.5%. Is that now 12%, or 8.85%?
Basis points eliminate room for misinterpretation of numerical statements: if the yield rate is 8.5% and increases 350 basis points, that’s an increase to 12% — if it’s 35 basis points, that would be 8.85%.
(The former journalism copy editor in me would also like to remind you that there’s a difference between 3.5% and 3.5 percentage points, and making the distinction has the same effect.)
How Does This Apply to Credit Card Processing?
Where credit card processing is concerned, you’re more likely to encounter basis points in discussions of card processing rates. However, there are a couple things to keep in mind:
If you’re on an interchange-plus plan, the rate your processor quotes you isn’t the entirety of what you’ll pay — you still need to pay interchange fees, which are the rates set by the card networks — Visa, Mastercard, Discover, American Express.
(If you’re on a tiered pricing model, you might also be quoted a markup percentage.)
You’ll likely pay a flat-fee to the tune of $0.10 to $0.25 per each transaction in addition to the percentage markup. This is important because a change in basis points can easily be offset by a change in this flat fee.
Here are a couple of contexts in which you might see basis points referenced:
- A company might offer you an interchange-plus plan where you pay 35 basis points over interchange plus a $0.20 per-transaction fee. That amounts to interchange + 0.35% + $0.20.
- You might also get notice that your processing rates are set to increase 8 basis points. If your current rate is 0.35%, that means your new rate is 0.43%.
It’s time to play with some numbers and see how changes in all of this could affect how much you pay!
Let’s set an interchange rate of 1.8% + $0.10 (note: interchange rates vary by card network, type of card, and type of transaction. this is just one example). Your processor offers you a 0.25% markup (that’s 25 basis points) plus a flat fee of $0.20 per transaction, bringing your total processing cost to 2.05% + $0.30. Your average transaction size is $12.
12 x 0.0205 = 0.246
Rounded up, that’s $0.25 + $0.30, or $0.55 in processing costs for a $12 transaction, leaving you with $11.45.
But what if that changed? Say your processor lowered your markup to 15 basis points (0.15% over interchange) but raised your per-transaction costs 10 cents to $0.30. Your new rate, with interchange, would be 1.95% + $0.40. How would that change what you pay?
So in this example, even with a lower percentage, your savings are offset by just a $0.10 increase in your per-transaction costs. Beware of this issue — do the math instead of just assuming it will translate to bigger savings!
But that’s just one transaction. How does this play out on a larger scale? Let’s go back to our original example, but also look at what happens when you up the average transaction size, or decrease the markup percentage but increase the flat fee.
As you can see here, changing even just one variable in the equation can have a dramatic effect on your processing rates. And if your average ticket size is small, the flat per-transaction fee can be more costly than the interchange and percentage markup. That makes it very important to do the math on your processing costs.
Also remember that interchange rates vary from one card network to the next, and from one type of transaction to the other. So your rates will vary based on your industry, and even what type of card you swipe (business cards and rewards cards cost more than standard credit cards, for example).
Where to From Here?
Educated merchants make for good merchants. That’s why we’re here — to share our expertise and give you the knowledge you need to succeed.
If most of what we’ve covered so far just made your eyes glaze over, here’s the big takeaway: You need to understand what you’re paying for credit card processing, no matter how your account rep explains it.
If you don’t understand how your rates work, do some research or ask someone to explain it to you. If your processor can’t do that, you probably want to start looking for a new one. You can start by checking out our top-rated merchant account providers.
Even if you are a small merchant, you have power. You do not have to accept the first offer a merchant account provider gives you. Educate yourself about your options. Know the risks in your industry. If you need help securing a good deal on processing, check out our guide to negotiating with card processors.
Thanks for reading, and good luck!