Interchange fees are easily the most confusing transaction fees you need to understand as a merchant, but they are also arguably the most important.
They make up the bulk of the fees you pay and can vary widely across industry and customer base, and it’s all too common for shady merchant services providers to charge extra percentages or purposely confuse clients on the terms of interchange in hopes of getting more money.
We’re sick of seeing that happen, and that’s why we’re writing this blog: to bring some clarity to interchange fees.
The easiest way to understand interchange fees is by first understanding the basic definition and reasons why they exist before digging into the variations and more complex aspects of how interchange affects your business.
With that in mind, let’s start at the top.
What are interchange fees?
Interchange fees are what the issuing bank charges merchants for the convenience of seemingly instant deposits. They're designed to pay for the billing services, risk, and costs the issuing banks incur while transferring money to merchants from the cardholder.
In other words, it’s the underlying cost you as the merchant have to pay for the “convenience” of accepting credit cards, and it’s the same for every single merchant. All of them. Everywhere.
So, when you see an interchange fee, think to yourself "Visa’s cut". These fees are standardized and the sandwich shop down the street pays the same rate that the professional association in an office building pays.
When you accept a credit card, you typically pay a combination of three payment fees: transaction fees, flat fees, and incidental fees. Every party involved in a credit card transaction charges one of those types of fees.
The parties involved are:
- The credit card association. Companies like Visa, Mastercard, Discover. They ultimately control the credit card ecosystem.
- The credit card issuing bank. These are banks like Chase and Wells Fargo that issue credit cards. Keep in mind that sometimes the association and issuing bank are one and the same, like American Express.
- The credit card processor. These handle the communication between all relevant parties, ensuring safe and accurate transactions, and come in all shapes and sizes.
- Merchant account providers. These companies handle the service end, everything from sales to support to complementary software.
- Your chosen payment gateway. These are software portals that digitize and handle online transactions.
Each player has to get their cut, and you’ll need to be diligent about the terms each player you’ve chosen sets.
Interchange fees are in the transaction fees category charged by the issuing bank, and they represent the bulk of what you pay on each individual transaction.
Why interchange fees exist
Interchange is all about incentive balancing and growth. There are three entities that need to be satisfied during a credit card transaction process: the merchant, the issuing bank, and the credit card association (Visa, Mastercard, etc.).
The idea is to set a rate that pays the issuing bank enough to compensate for the risks it incurs during the direct transfer of funds while also giving enough incentive to the card associations to sign up more people for credit cards — all while providing that “convenience” at a rate that doesn’t make merchants decide it’s not worth it.
It may not sound too convenient for merchants, but customers love to pay with credit cards, and that convenience is the instant sales and flexibility you can offer your customers.
It’s not surprising that this balance is often precarious and has been the source of much contention over the years — e.g. merchants banding together to pass surcharge laws in their respective states.
The varying kinds of interchange rates
Here’s the kicker: there are TONS of interchange rates, and they are typically updated twice a year, every year. These rates vary by industry, size of business, size of the transaction, and all sorts of other variables. It all goes back to that aforementioned balance. These rates change to make sure growth is being incentivized across the board.
Here are a few more common examples:
- The bigger the transaction rate the more the interchange fees are to compensate for float and fraud risk.
- The more perks a credit card has, the higher the fees.
- The less secure a transaction is, the higher the fees (so if you manually enter or swipe instead of using an EMV chip, your fees will be higher).
And all of those variables change by the card association, and all merchants are subject to all of those fees in order to accept that credit card association’s fees.
Interchange rates are typically displayed as Percentage X + Transaction Fee X, like:
1.6% + $0.10
Or something similar.
Are interchange rates negotiable?
No. If your processor tells you that they have the best interchange rate, run away fast! Because interchange rates are fixed prices, the only merchants (if you can call them that) that hold enough sway to negotiate with someone like Visa are the Walmarts of the world.
If you’re not close to Walmart in transaction volume, you’re getting the same, standardized rate as everyone else. This puts more power in your hands since you know that the best processor is one that is upfront and honest with you about what effective rate they’re offering and not one that says they can “get you a discount on interchange”.
You may be thinking, well if there are that many rates and it’s impossible to keep up with them as a business, then why try? Why shouldn’t I just pay a flat rate from my merchant services provider?
Well, let’s take a look at that.
How interchange relates to growth
So we know that there are hundreds of different types of rates across the different card member associations, and that’s why many merchant services providers simply charge a flat fee (e.g. 2.9% + $0.10) per transaction that covers ALL interchange fees.
The idea is some will be higher than the flat rate and some will be lower, so ultimately you pay for fewer headaches and just know exactly what you’re paying per transaction. Easy peasy, right?
Well… not exactly.
Let’s be clear: flat rates can be fantastic for small businesses. Anyone processing under $10k/month can see a lot of good from flat rates. However, as your business grows above and beyond $10k/month, and especially if you are a 6-8 figure business, you need to have interchange pricing from your merchant services provider.
Think about it. What if you never conducted a proper analysis of your interchange fees and failed to recognize that 60-70% of the transactions you accept are actually under the flat rate you’re paying?
Say you accepted 10,000 $100 transactions a month, and roughly half of those came out to 3.1% interchange fees and the other half hovered about 1.6% but you were paying a 2.3% flat rate. That means you’d be paying $23,000 at that 2.3% rate.
Now, in the simplest interchange rate example ever, let’s break down your actual rate costs:
$13,500 at 2.7% + $7,500 at 1.5%
That’s $21,000 — a savings of 2k per month, or 24k a year.
Who knows what you could save by digging into the individual interchange rates. Chances are it would be even more. Some merchants save up to 35% when they switch from flat rates to interchange plus pricing.
If you conduct more than 10k in transactions per month, we highly recommend getting a payment analysis or contacting your existing MSP and moving away from a flat rate. You could be leaving serious money on the table.
Understanding interchange becomes increasingly more important as you grow, but you don’t have to handle it yourself; there are businesses who will do that for you.
The first step is finding a merchant services provider who has a partnership mindset — one who keeps up with that volatility and passes those savings onto you whenever they become available.
Hopefully, you learned a bit about interchange and understand how it affects your business. If you have any more questions about interchange and want to learn a bit more about it in the context of your business, then give us a shout.