What Are Interchange Fees For Credit Card Processing?
If you’re new to the world of credit card processing, you may be wondering what interchange fees are, and how they impact the cost of processing transactions and maintaining a merchant account for your business. The truth is that interchange fees (or, more properly, interchange reimbursement fees) are, in most cases, the single largest expense you’ll have to pay when accepting a customer’s credit or debit card.
Interchange reimbursement fees vary wildly based on a number of factors, and you’ll usually have little or no control over them. Separating your interchange costs from the markup your merchant services provider is charging you can also be tricky, depending on what type of processing rate plan you’re using.
In this article, we’ll explain what interchange reimbursement fees are, where they come from, and the factors that go into deciding what fees you’ll pay for a given transaction. We’ll also show you how these fees fit into each of the different processing rate plans that your merchant account might be using.
Table of Contents
Interchange Reimbursement Fees
Every single credit or debit card transaction your business processes will involve the work of several different business entities, and they all want their cut in exchange for their services. Interchange reimbursement fees are initially collected by the credit card association that sponsors your customers’ cards. In the United States, the major credit card associations are Visa, Mastercard, Discover, and American Express. Interchange fees are paid to the issuing bank, which is simply the financial institution that sponsors your customers’ credit card.
Here’s where it starts to get complicated. Visa and Mastercard both publish their own interchange rates schedules that cover every possible type of transaction you could encounter. Discover and American Express also have their own interchange fee schedules. The main difference here is that Discover and American Express function as both the issuing banks and the sponsoring credit card associations. On the other hand, Visa and Mastercard merely slap their logo on cards that are actually issued by a bank. The issuing bank is the entity that’s advancing credit to consumers and taking on the risk associated with doing so, and they end up collecting almost all of the interchange fees charged on a transaction.
Now, you might think that the card-issuing banks make most of their money from collecting late payment fees and charging interest to consumers who have let their credit card debt pile up over time. Although this is certainly a lucrative source of income (and consumer credit card debt is a huge national problem), the fact is that interchange fees account for most of a bank’s profits when their credit cards are used, even when the cards are used by responsible consumers who pay their full credit card balance on time, every month.
What About Network Fees?
Visa and Mastercard do not serve as issuing banks, as we mentioned above. But they do charge a separate network fee for each transaction, and this also comes out of your total cost for processing a transaction. Network fees are very small (typically around 0.05% per transaction), and they aren’t considered to be part of the interchange. For example, the network fee on a hypothetical $100.00 transaction would only be $0.05. While this doesn’t sound like very much money, remember that there are literally billions of Visa and Mastercard transactions being processed around the world every year. Those small fees add up quickly. In 2017, Mastercard alone racked up a little over $6.6 billion in net revenue.
Here’s the important thing that you, the merchant, need to understand: although you’ll have to pay the interchange on every credit/debit card transaction, it’s only part of your total cost for processing. Your merchant services provider needs to get their cut, too. However, the interchange is usually the largest single expense in processing a transaction. Depending on your processing rate plan, roughly 70 to 90% of the transaction processing costs go to paying the interchange reimbursement fees. Your processor and the credit card association get the remaining 10 to 30%.
Factors Affecting Interchange Rates
As we’ve mentioned above, interchange rates vary widely depending on a number of factors, and there are literally hundreds of possible rates that you might have to pay. Here’s a very generic example of possible interchange rates:
Common Interchange Rate Examples
1.51% + $0.10
1.80% + $0.10
Signature/Traditional Rewards Credit:
1.65% + $0.10
1.95% + $0.10
Preferred Rewards Credit:
2.10% + $0.10
2.10% + $0.10 / 2.40% + $0.10
Small Bank (Exempt) Debit:
0.80% + $0.15
1.65% + $0.15
Big Bank (Regulated) Debit:
0.05% + $0.22
0.05% + $0.22
The rates in the table above, of course, represent only the tip of the iceberg. In the United States, the average interchange rate is around 0.3% for debit cards and 1.8% for credit cards. However, we’d caution you that these numbers have very little value due to the enormous range of possible rates under which any given transaction might fall.
The actual interchange rate for a specific transaction is based on a number of factors that generally correlate to the level of risk taken on by the issuing bank in approving it. Here’s an overview of the most important factors that influence your transaction’s interchange rate:
Debit Versus Credit Cards:
As noted above, interchange rates for credit cards are usually around six times higher than they are for debit cards. Why? Debit card transactions are much easier (and safer) to approve. Because the funds come directly out of the customer’s linked bank account, transaction approval is a simple process of confirming that there are sufficient funds in the account to cover the cost of the transaction.
Credit card transactions, on the other hand, require the card-issuing bank to extend credit to the customer and then cover the cost of the transaction themselves. The customer is responsible to repay the bank for the cost of the transaction at a later date. In most cases, credit card transactions will usually be approved as long as they don’t exceed the credit card account’s credit limit. However, with credit card fraud on the rise, many banks are now taking additional security measures to try to stop potentially fraudulent transactions, further complicating the approval process.
As you might imagine, accepting a credit card for payment is inevitably going to be riskier if the merchant never sees the actual card. eCommerce, mail order, and telephone order transactions will always be card-not-present and impose greater risks to the issuing bank. You might also encounter a card-not-present transaction in a retail setting if your terminal can’t read a customer’s card and you have to key in the card information manually. This is a frequent problem with magstripe cards, where the magstripe wears down over time and eventually can’t be read by a credit card machine.
Today, the use of EMV cards, which contain embedded chips, significantly decreases the likelihood of encountering this problem. Interchange rates for card-not-present transactions are substantially higher than those for card-present transactions. In most cases, the total processing rate that your merchant services provider charges you will directly reflect the additional cost to process these types of transactions.
Credit card associations further break down their interchange fees according to business categories (i.e., restaurants, gas stations, general merchandise, etc.). It’s a good idea to familiarize yourself with the underlying interchange fees associated with your business category.
In recent years, issuing banks have been offering rewards cards that come with perks such as frequent flier miles or cash back on purchases. Guess who ultimately gets to pay for these perks? That’s right, you do!
Interchange fees are inevitably going to be higher if your customer chooses to pay with a rewards card. Use of rewards cards particularly impacts your processing costs if you’re on a tiered pricing plan. Tiered plans often downgrade these transactions to nonqualified, and the rates for these types of transactions are frequently two or even three times higher than they are for qualified transactions.
Credit Card Brand:
Each credit card association sets its own interchange fees, so accepting one card brand might cost you more than another. American Express, in particular, has been singled out for criticism over the years for charging higher fees than either Mastercard or Visa. However, the company’s OptBlue program now makes it much more affordable for small businesses to accept American Express cards. Note that American Express charges a “discount rate” rather than an interchange fee, but it’s essentially the same thing.
Use Of Address Verification Service (AVS):
Whenever you accept a card-not-present transaction, your processor will have to query the Address Verification Service (AVS) to confirm that the address supplied by the customer and the billing address on file with the issuing bank match. Depending on your processor, you might be charged an AVS fee for using this service (usually $0.05 to $0.25 per transaction). However, using AVS to confirm this information will also qualify you for a much lower interchange fee. In general, the savings from the reduced interchange rate will outweigh the cost of the AVS fee. eCommerce, mail order, and telephone order merchants should confirm how AVS fees are charged and the impact they’ll have on their processing costs when setting up a merchant account.
Note that these are only the most significant factors affecting interchange rates. There are many other, minor factors that can influence your interchange costs. For a deeper dive into rate specifics, we highly recommend that you take a look at the Visa USA Interchange Reimbursement Fees and the Mastercard 2018–2019 U.S. Region Interchange Programs and Rates. These documents break down every possible interchange fee to which your transactions might be subject. Visa and Mastercard update their interchange rates twice a year (in April and October), so if the link above doesn’t work, do a Google search instead. You can also find the rates for Discover and American Express online with a little searching.
Interchange fees also vary by country, with rates in the United States usually being the highest. The main reason for this is that there are no legal limits on how much the banks can charge for interchange fees in the US. While competition between the various credit card associations has helped to keep US interchange rates from getting too high, the general trend has been upward. In fact, average interchange rates have more than doubled within the last ten years. This steep increase in interchange fees led the European Union to impose strict limits in 2015. Since then, interchange rates are limited to a maximum of 0.2% for debit cards and 0.3% for credit cards in EU countries. Unfortunately, the chances of such a consumer-friendly law being passed in the United States in the foreseeable future are essentially nil.
How Processors Treat Interchange Fees
Since credit card processors have to pay the interchange fees and still charge for their services, they’ve come up with numerous ways to pass those costs onto you. In discussing processing rate plans, note that processors often refer to the costs they have to pay as the wholesale rate. This is essentially the same thing as the interchange fee.
Processing rate plans generally follow one of two approaches in how they treat interchange fees. The pass-through approach, found in interchange-plus and subscription pricing plans, separates the interchange and the markup. With one of these plans, you’ll always know exactly how much of a cut your processor is taking from a transaction, even if you don’t know the interchange rate in advance. While your processing costs will vary quite a bit due to variations in the interchange rates, you’ll generally save money overall with this approach.
On the other hand, the blended approach, found in flat-rate and tiered pricing plans, combines the interchange and the processor’s markup into a single charge, usually leaving you with no idea how much of your processing fee is going to the issuing bank and how much is going to your processor. While the blended approach may make your processing costs more predictable, you’ll often end up paying more overall for processing with this approach.
Common Processing Rates Plans
Here’s some more detail on how the various processing rate plans treat interchange and markup costs:
1) Flat-Rate Pricing
This type of processing rate plan makes your rate structure as simple as possible by only charging one of a very small number of possible rates. Your processing costs are predictable and easy to understand. However, flat-rate pricing blends the interchange fee and the processor’s markup into a single rate, so you’ll never know how much you’re paying in markup.
Popular payment services providers (PSPs), such as Square (see our review), use flat-rate pricing. Our biggest gripe with this kind of pricing plan is that most providers who use it charge the same rate for both debit and credit cards. Under this approach, you’ll be paying far more to process debit card transactions than you would under an interchange-plus or subscription-based pricing plan.
At the same time, PSPs usually don’t charge any additional fees to maintain your account, so it’s reasonable to expect them to recoup those expenses through your processing costs. Flat-rate processing is a good deal for businesses with a low monthly processing volume, but can quickly become very expensive once your monthly volume grows above a certain amount (typically around $5,000 per month).
2) Tiered Pricing
With tiered pricing, you’ll get the worst of both worlds. Like flat-rate pricing, processing rates are simplified and generally predictable. Rather than pay a single flat rate every time, however, your transactions will be rated as either qualified or nonqualified. Some processors also use a mid-qualified tier. These tiers are structured to guarantee that the processor makes a profit regardless of the underlying interchange rate, so you’ll often be paying an unusually high markup.
To make matters worse, it will be nearly impossible for you to determine how much you’re paying in markup, as it’s blended in with the interchange fee. You’ll also have to pay all those account fees, gateway fees, PCI compliance fees, and other fees that merchants on a flat-rate plan don’t have to pay. Tiered pricing plans ensure maximum profit for your processor – at your expense. Needless to say, we don’t recommend them.
3) Interchange-Plus Pricing
For most merchants processing at least $5,000 per month, interchange-plus pricing plans are usually the most transparent and affordable plans you can get. Interchange fees are passed-through at cost, and your processor’s markup is fully disclosed in your rate quote. Yes, you’ll still have to pay all those pesky monthly and annual fees. However, the savings in processing costs will more than offset them, as long as your processing volume is high enough. You’ll also save money on debit card transactions, as your cost will be based directly on the applicable interchange rate.
4) Subscription Pricing
Also called membership pricing, subscription-based pricing is similar to interchange-plus in that it separates the processor’s markup from the interchange. The main difference is that your processor will charge you a single monthly subscription fee instead of a multitude of separate account fees.
Some providers, such as Fattmerchant (see our review), also eliminate the per-transaction percentage and just charge a flat per-transaction fee in addition to the interchange costs. However, the high monthly subscription fee means that this type of pricing will work best for established businesses with significant monthly processing volumes. You’ll want to analyze your potential costs very carefully before signing up for this type of pricing plan.
Here’s a quick overview of how the various processing rate plans treat interchange fees:
Pricing Model Overview
|Interchange Fees||Model Type||Generally Best For|
Separate from markup
Separate from markup
Blended with markup
Blended with markup
Also, here’s a comparison of possible rate quotes you might receive, what type of pricing plan they represent, and whether the wholesale interchange rate is included in the rate quote:
Sample Quoted Processing Rates
|Pricing Model||Wholesale Rate|
0.25% + $0.10:
$0.10 (+ $99/Month Membership):
Qualified: 1.79% + $0.10
(Mid-Qualified: 2.19% + $0.15)
(Non-Qualified: 2.99% + $0.20)
2.90% + $0.30 Online:
By now, we hope you have a clearer idea of what interchange fees are and how they affect your processing costs. We’d love to conclude by offering you some great insider tips on how you can lower or even eliminate interchange fees, but unless you’re a mega-retailer such as Amazon or Walmart, it’s just not going to happen. Be very wary of any sales representative from a merchant services provider who offers to get you a discount on the standard, published interchange rates. They either don’t know what they’re talking about, or they’re deliberately trying to mislead you.
The only way to reduce or eliminate your interchange costs is to pass them on to your customers. This involves surcharging, where your customers pay a higher price for using credit or debit cards to cover your processing costs. Some providers try to refer to this as a “cash discount” program, but it still inevitably results in surprising a customer with an additional 2-3% tacked onto their bill when they go to the cash register. Customers don’t like this kind of surprise, and you’ll probably lose more money in potential sales than you’ll save in processing costs. Surcharging only works well in certain industries (such as taxi cabs) where the practice is common and accepted, and your competitors are already doing it.
Despite the expense and headaches of maintaining a merchant account, the bottom line is that you’ll almost certainly make more money from increased sales by accepting cards than you’ll pay out in interchange fees. This will also hold true if you sign up with a top-notch merchant services provider who won’t charge you excessive processing rates and fees. If you’re looking for a provider for your new business or are considering switching from your current one, take a look at our Merchant Account Comparison Chart for side-by-side comparisons of our top-rated providers.