Interchange fees explained

Understanding the cost of a transaction is a key metric for any merchant. That said, different payment methods attract different costs. For card payments, one of the most significant is known as the "interchange fee". Yet, many merchants don't have a clear view of what it is or how much it costs. That makes it harder to manage costs more broadly, and can harm profit margins.

What are interchange fees?

Interchange fees are transaction fees that merchants must pay when taking payment via credit or debit card. Interchange fees cover:

• handling costs
• financial losses due to fraud
• the cost of bad debts
• maintenance of the payment infrastructure

All issuing banks expose themselves to risks when they give credit cards to consumers; however, they offset those risks by charging the merchants that accept their cards.

Let's remind ourselves of what happens when a card payment takes place. The merchant's bank (the acquirer) sends a payment request to the customer's bank (the issuer) via the card network. The issuing bank then performs a number of checks to determine whether to accept or reject the request, mainly to ensure that the card isn't being used fraudulently and that the customer has the necessary funds or credit in their account.

The issuing bank then deposits the money with the acquiring bank—or sends a rejection notice. Though all this happens in the blink of an eye, it's a complex process for which the issuing bank gets paid. This is known as the interchange fee.

In theory, the interchange fee is charged by the card scheme to the acquiring bank. However, the card operator passes this fee to issuing banks as an incentive for the banks to offer and promote their card over others. That's why most people understand the interchange fee as taking place between the issuing bank and acquiring bank.

In practice, the issuing bank withholds the value of the interchange fee, and the acquiring bank simply passes this balance through when they deposit the funds in the merchant's account. So, in the end, it's the merchant that foots the bill.

How do interchange fees work?

Interchange fees are charged every time a consumer makes a transaction using their credit or debit card. The fees are charged to the payment processor who acts on behalf of the merchant. The payment processor then passes the fees on to the merchant, as part of its overall charges for payment services.

Depending on which pricing model you have with your payment services provider, you may see the interchange fees itemized separately, or bundled in with other processing fees.  

There is no set rate, but, on average, interchange fees account for between 0.3% and 3% of the total transaction cost and between 70% and 90% of all fees that merchants pay to banks.

Additionally, interchange fees are not static, and are frequently adjusted by banks and card networks to account for changes in transfer costs, interest rates, and relative risk. Visa and Mastercard change their rates every April and October.

How do interchange fees influence businesses?

In some cases, businesses might adapt their business models in order to take advantage of lower interchange fees. They can do this by encouraging their customers to pay using cash or debit cards, or, where legal, charge customers a fee to pay with a certain card – known as surcharging. 

Another way interchange fees can influence businesses is in their choice of payment processor. Payment providers may negotiate different rates with card schemes, meaning they can offer more competitive rates to certain merchants, depending on a few factors, such as transaction volume and customers’ preferred payment methods.  

How are interchange fees calculated?

Though the interchange fee is, ultimately, settled to the issuing bank, the rate is set by the card networks. The interchange fee is made up of a percentage of the transaction value plus a fixed fee. That means each transaction type has a unique interchange fee attached to it, so it's very hard to estimate interchange fees in advance.

Instead, interchange fees vary by a range of criteria, including:

Card schemes

Debit and credit card transactions are processed on the payment rails owned by card schemes (such as American Express, Mastercard, and UnionPay).

Therefore, schemes manage the rules that allow consumers to make payments using their cards. After, all it's the brand of card and the specific rewards associated with each card program that determines whether or not a customer signs up and continues to pay with it. The issuing bank and the acquiring bank must be members of the same network as the card in order for the payment to be made.

Card schemes charge different interchange fees. For example, the cost of a consumer paying with a Mastercard isn't the same as a consumer paying with a Visa.

Credit card vs. debit card

Typically, interchange fees for credit cards are higher than for debit cards because it's easier and safer to approve debit card transactions. The reason: funds for debit card transactions come directly out of customers' linked bank accounts and it's easy to confirm that there are sufficient funds in those accounts to cover the costs of those transactions.

Reward cards

Issuing banks also offer rewards cards that include a variety of benefits, such as cash back on purchases or frequent flier miles; the interchange fees are generally higher for rewards cards as the increased fees pay for the extras offered by rewards programs. Rewards cards have a particularly negative effect on merchants on tiered pricing plans.

Card present vs. card-not-present

Interchange fees for card-not-present transactions, i.e., online as well as telephone and mail order transactions, are significantly higher than those for card present, i.e., in-person transactions, as the risk of fraud is lower when merchants are able to see consumers' cards. Generally, the total processing rate that a merchant services provider charges will include the added costs of processing these payments.

Merchant Category Code

The payments industry uses four-digit Merchant Category Codes (MCCs) to classify businesses based on the types of goods or services they sell. Credit card associations use MCCs to categorize interchange fees based on business categories, e.g., florists, restaurants, hardware stores, online marketplaces, etc. An organization's assigned MCC can have an impact on its interchange fees, as higher risk businesses, such as airlines, typically have higher interchange fees. Merchants can find the current rates by checking the card schemes' websites or asking their payment services provider.

Security protocols used

The more secure transactions are, the lower the interchange fees. In the U.S., the Address Verification Service as well as card security codes are the most used fraud prevention tools. However, as fraud related to card-not-present transactions continues to increase, major credit card processors are developing new tools to mimimize the risk of fraud, such as tokenization. In April 2022, the major credit associations began charging lower rates to merchants using tokenization and higher rates to merchants not using it.

Country of transaction

Interchange fees vary depending on the country where the transactions occur. Interchange fees in European countries are lower than in North America. A European regulation limits interchange fees for consumer credit cards to 0.3% of the transaction's value and consumer debit cards to 0.2%. The regulation ensures that interchange fees are capped at a level such that retailers' average costs are not higher for card than for cash payments.

Where the card was issued

If the acquiring bank and the issuing bank are in different countries or jurisdictions, a higher interchange fee will reflect the additional complexity of the payment process.

The volume of transactions is also considered, with big merchants expecting to negotiate lower interchange fees. In other words, merchant interchange fees can vary and depend on what is being sold, where, how, by whom, and to whom. The overall interchange fee for each transaction is technically made up of hundreds of "mini" fees, which can lead to transparency issues when it comes to cost.

How much are interchange fees?

Interchange fees vary depending on your location. In the US, they are around 1.5% to 3% of the transaction amount. In Europe, they are around 0.3% to 0.4%. The differences are due to regulation in each of the regions.

The rates for each region are set by card schemes, like Mastercard and Visa, and are amended every April and October. Some schemes, like American Express, don’t make their rates available online.

Who pays interchange fees?

Merchants are billed by their payment services provider (PSP), so it's the business accepting card payments which pays the cost of interchange fees.

Whether or not to pass these costs on to consumers is another factor to consider. In 46 of 50 US states, merchants are allowed to apply surcharges to credit card payments covering up to 3% of the transaction cost. That means, as long as you give your acquirer 30 days notice that you’re planning to surcharge, you can pass the cost of interchange fees onto your customers. 

In the UK and the EU, surcharging is banned for most credit and debit card transactions. That means merchants trading in these regions cannot recoup the cost of interchange fees at the point of sale, but may consider raising the price of goods or services overall to cover them.

How do merchants pay interchange fees?

Merchants pay interchange fees indirectly, by paying their PSP on a regular billing cycle. Below are the main billing models.

Interchange ++

Also known as cost plus pricing, on an interchange ++ model, you pay an exact fee to the card scheme, as well as a small fixed percentage per transaction, which is determined by the payment processor. Interchange ++ is considered to be the most transparent model because, although the per transaction percentage fee can fluctuate, you will always know how much you’re paying over the base fee.

Tiered pricing

There are three tiers - qualified, mid-qualified and non-qualified - based on the relative risk of each transaction. Each tier has its own rate. The lowest rate tier, qualified, is charged on payments involving basic credit cards with no reward scheme. On the other hand, payments made using reward credit cards will be categorized as non-qualified and charged the highest rate. For businesses, the criteria that determine which tier a payment will fall into are not completely transparent, making it difficult to predict your fees. 

Flat-rate pricing

On the flat-rate pricing model, you simply pay a fixed percentage or flat fee for every transaction, or sometimes both. The rate is the same for all card and transaction types, which makes it very predictable. However, it does mean you will pay more in fees than you would on interchange plus, for example. It can be a good option for smaller businesses with low sales volumes.

Subscription pricing

On the subscription model, you pay a monthly membership fee in exchange for lower interchange fees. Instead of charging a percentage, the processor charges a smaller, flat per-transaction fee.

‍What is interchange++ pricing?

Interchange++ pricing is a type of pricing available for payments. Interchange++ pricing provides more transparency than other pricing types as it shows merchants detailed breakdowns of their costs. Interchange ++ pricing comprises two elements: the first plus, which is the acquirer's fee, and the second plus, which is the card scheme fee. Typically, card scheme fees, which are determined by such factors as card and transaction types, are significantly lower than interchange fees.

Larger merchants tend to use interchange++ pricing because it offers total transparency into what the fees are for every transaction. If, for example, a merchant observes that many of its buyers use debit cards, which are charged a lower interchange fee than credit cards, the retailer can tweak its marketing to urge shoppers to use that specific method of payment.

48% of merchants do not receive a detailed breakdown of their payment costs from their payment service providers. Switching to a provider that offers Interchange++ pricing can help merchants solve this issue by giving them more transparency into the fees they pay.

Interchange++ pricing vs. blended pricing

Another type of pricing that payment processors offer is blended or standard pricing, which bundles all the costs of processing transactions into a single fee known as the Merchant Service Charge. That means payment processors blend interchange fees, scheme fees, and markup fees together and present them to merchants as one fixed percentage.

An advantage of blended pricing is that it's easier for merchants to understand and plan for because fewer variables are involved. However, blended pricing is less transparent, making it easier for acquiring banks to conflate fees so they can earn more profit.

With a blended pricing model, merchants are charged a gateway fee, which is a fixed cost per transaction and a variable fee. The variable fee encompasses the interchange cost, the scheme cost, and the acquirer's mark up. Merchants are however unable to see the split.

On the other hand, Interchange++ gives merchants more transparency over the fees they're being charged, enabling them to clearly understand the margin/profit the payment service provider makes. But because Interchange++ is a passthrough model, it is subject to cost fluctuations.

Will interchange fees decrease?

In recent years, interchange fees have attracted more attention from regulators. Although regulation has kept interchange fees comparatively low in the UK and EEA, the US has seen a lot less .

In the US, the Durbin Amendment caps interchange fees for debit and prepaid transactions at 0.05% of the transaction + $0.21. This does not apply to credit cards, although Senator Durbin has proposed new legislation which would affect credit card interchange fees, if enacted.

Since 2015, interchange fees in the European Economic Area (EEA) are capped at 0.20% for debit cards and 0.30% for credit cards. The only exception is for interregional card-not-present transactions, which are capped at 1.15% for debit cards and 1.50% for credit cards.

How does Checkout.com charge interchange fees?

Checkout.com uses the transparent interchange++ pricing model, billing transactions individually so that there are no hidden or additional costs.

Interchange fees may be inescapable, but how much merchants pay is not. Seemingly small percentage fees add up quickly and can become a drag on growth, especially for smaller merchants with tighter margins. For larger companies, ignorance of merchant interchange fees can mean millions in avoidable costs. But as we've seen with other aspects of payments, the innovative merchants will view interchange fees not just as a way to save money, but they'll also use the enhanced transparency and insights from interchange++ as an opportunity to make far-reaching and smarter data-driven decisions.

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