The Basics of Interchange Fees and Why They Matter

Interchange fees, a term that’s often thrown around in the world of merchant services, is a critical concept that every merchant should understand.

It’s a key component of the costs associated with accepting credit and debit card payments, and it can significantly impact the profitability of your business.

In this blog post, we’ll delve into what interchange fees are, how they are determined, and why they matter to your business.

What Are Interchange Fees?

Interchange fees refer to the processing costs charged by card issuers (i.e. banks) each time a customer uses a credit or debit card for payment. Every time a customer swipes or dips their card, the bank that issued that card charges a small “interchange fee” to the merchant’s bank to cover the cost of processing the transaction.

While customers don’t see interchange fees directly on their statements, merchants do have to pay them – and they can really add up.

For most small businesses, interchange fees represent the highest single expense involved in accepting credit and debit cards. That’s why understanding them and shopping around for the best rates is so critical.

How Do Interchange Fees Work?

Every time a credit or debit card transaction is processed, there are several parties involved, including:

The customer using the card to make a purchase
The merchant accepting the card for payment
The bank that issued the customer’s card
The merchant’s bank that processes the payment on behalf of the merchant
The credit card networks (e.g. Visa, Mastercard) that facilitate the transaction

When a purchase is made using a card, the issuing bank charges an interchange fee to the merchant’s bank (who provides a merchant account) to cover their costs of processing the payment and extending credit. The merchant’s bank then passes this fee along to the merchant as part of the discount rate or processing fees. There’s a lot more to it, which you can read about in our full processing guide.

But in summary: Issuing Bank ➡ Interchange Fee ➡ Merchant’s Bank ➡ Merchant

The credit card networks like Visa and Mastercard are the ones who actually set the interchange fee amounts that issuing banks can charge.

On top of these interchange rates, payment processors and merchant services providers usually add a small markup that they get to keep. The small markup is how they get paid for providing the software, hardware, and customer service required to make payment processing seamless for merchants.

How Are Interchange Fees Determined?

Interchange fees are set by the card networks (Visa, MasterCard, Discover, and American Express) and are typically a percentage of the transaction total, plus a flat fee.

For example, the interchange fee might be 1.51% + $0.10 for a particular type of Visa credit card transaction.

Several factors influence the interchange fee for a particular transaction. These factors include:

Type of Card: Different types of cards have different interchange rates. For example, rewards cards and business cards often have higher interchange fees than standard consumer credit cards because they offer benefits to the cardholders, like cash back or travel points.
Type of Transaction: Card-present transactions (where the card is physically swiped, dipped, or tapped at a terminal) usually have lower interchange fees than card-not-present transactions (like online purchases), as the latter carries a higher risk of fraud.
Merchant Category Code (MCC): Businesses are assigned a four-digit code by the card networks, reflecting the type of products or services they offer. Some categories have higher interchange fees because they are considered higher risk.
Transaction Size: Generally, the larger the transaction, the higher the interchange fee, as it’s usually a percentage of the transaction amount.

Aside from that, there are also several different buckets in which different types of cards fall into. These buckets also play a role in interchange fees.

While overall fee nuances are incredibly complex, the most common buckets include:

Qualified – The baseline rate for standard consumer credit card transactions
Mid-qualified – Slightly higher fees for cards missing data like billing zip codes
Non-qualified – Much higher fees for transactions deemed high risk
Debit card fees – Set fees for PIN and signature debit purchases

Why Do Interchange Fees Matter to Merchants?

Interchange fees are a significant component of the ‘discount rate’ – the total percentage that merchants pay to their acquiring bank for payment processing services.

Cost of Business: Interchange fees can add up quickly, especially for businesses with a high volume of card transactions. Understanding the basics of these fees can help merchants identify ways to minimize them and increase their bottom line.
Direct impact on your profit margins: Interchange fees represent a discount that is taken off the top of every credit and debit card transaction you process. The fees can really add up, so you want to minimize them as much as possible to maximize profits. Even small differences in your interchange fee rates can impact your bottom line significantly over time.
Pricing Strategy: Understanding interchange fees can also help in devising pricing strategies. Some businesses choose to impose a minimum transaction amount for card payments to offset the cost of the interchange fee, especially for small transactions.
Negotiating Power: Knowledge of interchange fees can be a powerful tool when negotiating the terms with payment processors. Processors often add a markup to the interchange fee, and knowing the base cost can help you identify and contest excessive markups.
Choice of Merchant Services Provider: Different merchant services companies handle interchange fees differently. Some offer interchange-plus pricing, where the interchange fee and the processor’s markup are listed separately on your bill. Others offer bundled or tiered pricing, where the interchange fees are included in a single, blended rate.

For most small businesses, interchange fees are one of the top three operating expenses alongside labor and rent. As such, it’s crucial to monitor these costs and stay up-to-date on ways to minimize costs.

How Can Merchants Minimize Interchange Fees?

While interchange fees are unavoidable, there are strategies merchants can employ to help minimize their impact:

Encourage Debit Over Credit: Debit cards typically have lower interchange fees than credit cards. If it’s feasible and appropriate for your business, consider encouraging your customers to use debit cards
Secure Card-Present Transactions: Whenever possible, try to process transactions with the card present to avoid higher interchange fees associated with card-not-present transactions
Use Address Verification Service (AVS): For online transactions, using an AVS can sometimes qualify you for lower interchange rates, as it reduces the risk of fraud
Ensure Accurate Business Classification: Make sure your business has been accurately categorized under the correct MCC, as some classifications incur higher interchange fees
Build Processing Fees into Your Pricing Strategy: Doing so ensures they don’t cut too deeply into your margins and are accounted for in your overall business strategy
Shop Around: Compare merchant services providers, including the fees and rates they charge.
Negotiate with Payment Processors: Use your understanding of interchange fees to negotiate the best possible rates with your payment processor

Final Thoughts

Interchange fees are an unavoidable reality for businesses accepting card payments. However, a good understanding of these fees can help merchants devise strategies to minimize their impact and boost their business’s profitability. It can provide the foundation for smart pricing strategies, informed decisions about payment processors, and effective negotiations for better rates.