Interchange fees – the basics: What they are, how they work and how to cut costs

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  1. Introduction
  2. What are interchange fees?
  3. How are interchange fees calculated?
    1. Visa
    2. Mastercard
    3. Discover
    4. American Express
  4. Interchange pricing models
  5. How do interchange fees work?
  6. How interchange fees affect businesses
  7. How businesses can reduce interchange fees

US businesses incurred about US$137.8 billion in card processing fees in 2021. Interchange fees, also known as swipe fees, comprised 70% to 90% of these card processing fees. For businesses that accept card payments from customers, interchange fees affect operating costs, pricing strategies and their business model. Overlooking these fees can generate unnecessary expenses that reduce profits.

Below, we'll explain how interchange fees work, discuss their implications for businesses and provide strategies for managing these costs effectively. By understanding interchange fees, businesses can turn potential financial hurdles into opportunities for growth. Here's what you need to know.

What's in this article?

  • What are interchange fees?
  • How are interchange fees calculated?
  • Interchange pricing models
  • How do interchange fees work?
  • How interchange fees affect businesses
  • How businesses can reduce interchange fees

What are interchange fees?

Interchange fees are transaction fees charged between banks for processing credit and debit card payments. When a customer makes a purchase using a card, the business's acquiring bank pays the interchange fee to the cardholder's issuing bank.

Card networks set interchange fees, which are typically a percentage of the transaction amount plus a fixed fee. The interchange fee depends on various factors, including the type of card used (credit or debit), the type of transaction (in person or online), the industry of the business, and the region where the transaction occurs.

Interchange fees serve several purposes:

  • Compensation for issuing banks: Interchange fees compensate the cardholder's issuing bank for the costs of providing and maintaining the payment card, managing the associated accounts and managing the risk involved in extending credit.

  • Incentives for issuing banks: Higher interchange fees can incentivise issuing banks to promote payment cards to customers. This encourages cardholders to use the cards, benefiting the banks and card networks.

  • Network maintenance: Interchange fees support maintaining and operating the card networks. They help cover the costs associated with network infrastructure, fraud prevention measures and other services provided by the networks.

  • Acquiring costs: Acquiring banks, which facilitate payment processing for businesses, pay the interchange fees as part of their cost structure. The fees help cover the issuing banks' expenses in processing card transactions and provide an incentive for them to offer card acceptance services.

Interchange fees differ from other fees that businesses may incur, such as merchant service fees, which are charged by acquiring banks or payment processors for handling card transactions on behalf of the business.

Some jurisdictions have regulated interchange fees because they can affect businesses' costs and potentially affect customer prices. Regulations and negotiations between various stakeholders can influence the structure and impact of interchange fees in different regions.

How are interchange fees calculated?

Interchange fees are calculated on the basis of several factors. These fees are set by the card networks – Visa, Mastercard, Discover and American Express – and can vary significantly, depending on:

  • Type of card: Different types of card have different interchange rates. For instance, rewards cards, business cards and premium cards typically have higher interchange fees compared with those of standard debit or credit cards. Issuing banks often use interchange fees to fund reward programmes.

  • Transaction method: How the card is processed also affects the interchange fee. For example, card-present transactions, in which customers physically swipe, insert or tap a card at a point-of-sale (POS) terminal, usually have lower fees than card-not-present transactions, such as online or over-the-phone payments. This difference is because of the increased risk of fraud in card-not-present transactions.

  • Merchant category code (MCC): The type of business or industry also influences the interchange fee. Different types of business have different levels of risk and different average transaction sizes, which are reflected in their MCC.

  • Size of transaction: Typically, the interchange fee is a percentage of the total transaction amount plus a flat fee. So larger transactions incur larger interchange fees in absolute terms, although they might be smaller as a percentage of the transaction.

  • Processing details: Certain specifics of how the transaction is processed can also affect the rate. For example, transactions in which the card information is manually keyed in or transactions not settled within a certain time frame might be charged higher rates because of the increased risk of error or fraud.

The formula for calculating interchange fees is complex and varies between card networks, but it typically involves a combination of the factors above. Each card network publishes its own interchange rates twice a year, in April and October. These rates can change, although consumer card interchange fees are capped at 0.2% for debit and 0.3% for credit cards in the European Union.

Here are the interchange rates for each of the major US card networks as of 2023:

Visa

Visa's interchange fees depend on various factors, including the type of card, the transaction method and the business's industry. View the links below for the most up-to-date information.

Mastercard

Similar to Visa, Mastercard's interchange fees vary based on multiple factors.

Discover

Discover's interchange fees also depend on the type of card, transaction method and industry.

American Express

American Express operates slightly differently; it often acts as the issuing bank and the card network.

Interchange pricing models

Payment processors use three primary types of pricing model to bill businesses for the interchange fees associated with card transactions. It's important for businesses to understand these pricing models because they affect the cost of accepting card payments. Here's an overview of the three primary models plus one less common one:

  • Interchange plus pricing (also known as cost plus pricing): This pricing model is considered the most transparent. With interchange plus, the business pays the exact interchange fee determined by the card networks plus a markup set by the payment processor. The markup is usually a small fixed percentage, a flat fee per transaction, or both. Because the interchange fee varies for each transaction, the total cost can fluctuate, but the business always knows exactly how much the processor is charging over the base cost.

  • Tiered pricing: In this model, the processor groups transactions into different tiers – usually three: qualified, mid-qualified and non-qualified – each with its own rate. The tiers are based on the risk and reward factors of the transactions. For example, transactions made with basic, non-reward credit cards may fall into the qualified tier with the lowest rate, while those made with premium reward cards may fall into the non-qualified tier with the highest rate. The challenge with this model is that it's often not clear which tier a particular transaction will fall into, making costs less predictable.

  • Flat-rate pricing: This is the simplest pricing model, in which the business pays a fixed percentage, a flat fee for every transaction, or both, regardless of the card type or transaction method. The rate doesn't fluctuate based on the interchange fee, making it predictable, but it's usually higher than what the business might pay with interchange plus pricing. This model is common with payment service providers, and it's often favoured by small businesses with low sales volumes.

  • Subscription/membership pricing: This is a less common model, in which businesses pay a monthly membership fee and receive lower transaction costs. The interchange fees are still passed through to the business, much like with interchange plus, but the processor's markup is often a flat per-transaction fee rather than a percentage.

Each model has advantages and disadvantages. The best choice depends on the specifics of the business, including sales volume, average transaction size and the types of card its customers typically use.

How do interchange fees work?

Interchange fees are involved in every card-based transaction. Here's a simplified explanation of how they work:

  • Transaction initiation: When a customer uses a credit or debit card to make a purchase, the transaction information is sent from the business to the acquiring bank.

  • Transaction authorisation: The acquiring bank then sends the transaction information to the card network, which passes it on to the issuing bank.

  • Transaction approval: The issuing bank checks the cardholder's account, confirms that there are enough funds or credit available, and then sends an authorisation back through the card network to the acquiring bank and ultimately back to the business.

  • Settlement: At the end of the working day, the business sends all of the day's authorised transactions to the acquiring bank in a batch. The acquiring bank sends this batch to the card networks for settlement. The card network routes each transaction to the correct issuing bank and debits the appropriate amount from the issuing bank's account.

  • Payment to the business: The card network transfers the total amount of the batch to the acquiring bank minus the interchange fees. The acquiring bank then deposits the funds into the business's account minus its own fees.

The interchange fee is part of the total transaction amount that the acquiring bank transfers to the issuing bank. It compensates the issuing bank for its role in the transaction process, including the risk it takes on by guaranteeing payment and the value it provides by issuing cards and maintaining cardholder accounts.

How interchange fees affect businesses

Interchange fees can have a significant effect on businesses – particularly those that rely heavily on card transactions. Here are some areas of the business that could be affected:

  • Operating costs: Interchange fees are a significant part of the costs that businesses pay to accept card payments. For every card transaction, a portion goes towards these fees. For businesses with thin margins or high volumes of card transactions, these fees can add up quickly and significantly affect their bottom line.

  • Pricing decisions: To absorb the cost of interchange fees, businesses may need to adjust their pricing strategies. This could mean increasing the prices of goods or services or implementing minimum transaction amounts for card payments. These decisions can affect competitiveness and customer satisfaction.

  • Cash flow: Interchange fees can affect a business's cash flow because the fees are typically deducted from the transaction amount before it's deposited into the business's bank account. This means that businesses must account for these fees in their financial planning and forecasting.

  • Business model: Interchange fees can also influence the business model. For instance, some businesses might incentivise cash or debit card payments, which typically have lower interchange fees than credit card transactions. Some might charge a surcharge for credit card transactions (where it's legal to do so) or not accept cards.

  • Choice of payment processor: Interchange fees can also influence a business's choice of payment processor. Different processors use different pricing models. The best payment processor for a particular business depends on its transaction volume and size, the types of card its customers use, and its tolerance for variable costs.

How businesses can reduce interchange fees

Reducing interchange fees can be complex because the card networks set the rates, which vary based on numerous factors. However, businesses can employ a few strategies to help minimise these costs, including:

  • Negotiating with your processor: If your business processes a high volume of transactions, you may be able to negotiate lower rates with your payment processor.

  • Choosing the right payment processor: As discussed above, different payment processors use different pricing models. Depending on your business's circumstances, you might be able to reduce your costs by choosing a processor with a pricing model that aligns better with your transaction patterns.

  • Improving card processing practices: Businesses can often qualify for lower interchange rates by following the card networks' best practices for card processing. This includes:

    • Settling transactions promptly: It's best to settle transactions with your processor as soon as possible – typically within 24 hours.
    • Handling card data securely: Implementing secure processing technologies, such as point-to-point encryption and tokenisation, can help businesses qualify for lower interchange rates.
    • Providing complete transaction data: For certain types of card, particularly corporate and government cards, providing additional transaction data (known as Level 2 and Level 3 data) can result in lower interchange rates.
  • Encouraging debit card or cash transactions: Debit card transactions typically incur lower interchange fees than credit card transactions. Similarly, cash transactions have no interchange fees. Encouraging customers to use debit cards or cash can help reduce your interchange costs.

  • Implementing a surcharge or service fee: In some areas, businesses are allowed to add a surcharge or service fee to credit card transactions to cover the cost of interchange fees. However, this practice is regulated and isn't allowed in all areas or for all types of card, and it can be unpopular with customers.

  • Reviewing your processing statements regularly: Interchange fees can change twice a year, so it's important to review your processing statements regularly to make sure you're aware of any changes and understand all the fees you're being charged.

Although reducing interchange fees can improve a business's bottom line, businesses should consider the impact that any change might have on the customer experience. The best solution is to balance financial returns with the optimal experience for customers. To learn more about Stripe's pricing model, go here.

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