Credit card usage among consumers is on a clear and undeniable rise. Consumers are adapting to an increasingly digital shopping landscape and making payments facilitated by payment cards.
The number of credit cards in circulation crossed 540 million in Q1 of 2024 from 523.3 million in Q1 of 2023. The same report also shows that credit card usage for all transactions in 2023 was just over 32% compared to only 18.18% in 2016.
When it comes to monthly payments, credit cards are the most preferred payment method (32.6%). With increased market potential, retailers want to maximize their profits by minimizing credit card processing fees. In this article, we’ll help you learn how the interchange fee fits into the equation and how merchants can lessen its impact.
Let’s dive in.
What Are Interchange Fees?
Before we understand how to minimize credit card processing costs, we need to define interchange fees. The term “interchange fees” is the shortened version of “interchange reimbursement fees.” These are the fees that businesses are compelled to pay to card-issuing banks as reimbursement for lost card interest. Banks lose interest when cardholders use the grace period to repay their debts.
The interchange’s multiple categories determine the rate for an individual credit card or debit card transaction. Each category features eligibility requirements along with a corresponding interchange rate. To understand how credit card interchange fees work, it is essential to know that they are involved in every card-based transaction, covering the process of transaction initiation, authorization, approval, and settlement, and the allocation of interchange fees between acquiring and issuing banks.
What do interchange fees cover?
An interchange fee applies to each credit card or debit card sales/service transaction. Examples include a retailer’s product sale or a field-based plumbing services payment. During the transaction, the merchant’s bank (the acquiring bank or acquirer) pays an interchange fee to the customer’s bank (or issuing bank).
The interchange fees for credit cards cover the issuing bank’s fraud transaction risks. In addition, the fees pay for transaction processing costs. Proper and complete transaction data is crucial for credit card transactions, especially for card-not-present transactions and for dealing with corporate and government cards. An interchange fee is derived by applying a specific interchange rate (or percentage) to the purchase amount.
Credit card interchange fees range from 1.5% to 3.3% on average. Payment processing fees are an additional expense. Note that Visa card transactions carry the lowest fees. However, Mastercard and Discover transactions incur only minimally higher costs.
Key Interchange Fee Regulations
Regulations to interchange fees have shaped the credit card payments industry since 2010. A notable example is the Durbin Amendment which is a part of the Dodd-Frank Act. Senator Richard Durbin introduced this act to set a cap on debit card transaction fees and reduce card processing costs for businesses.
Before this amendment was passed, interchange fees averaged $0.44 per credit card transaction, which amounted to 1-3% of the total transaction amount. Senator Durbin criticized this as being too excessive and unreasonable.
In his original proposal of the Dodd-Frank Act, he wanted to cap the interchange fee at $0.12 per transaction for banks with assets that equaled or exceeded $10 billion. However, after legislative adjustments, the final law was able to limit the interchange fee to $0.21 per transaction plus 0.05% of the transaction amount.
Unsurprisingly, many banks were dissatisfied and responded to this act by eliminating free services and adding new fees to offset the reduction in revenues due to this change in interchange fee caps.
Who sets interchange fees?
Credit card networks (aka credit card issuers, card associations, or payment networks) establish their respective interchange fees. Mastercard, Visa, American Express, and Discover are the major credit card networks (or credit card companies).
Interchange fees make up the biggest portion of credit card processing costs for merchants. Some estimates say that interchange fees comprise 70% to 90% of total card processing fees. For larger merchants, interchange fees make up a smaller percentage of their card transaction expenses.
Recent Updates on Interchange Fees
When it comes to interchange rates, credit card networks like Mastercard and Visa update them regularly—usually in April and October. The rates can go up or down so pay attention to notifications from your payment processors and banks.
In 2018, Amex (American Express) made its largest reduction in credit card processing fees in 20 years. Review your processing statements to stay informed about these fee changes and any additional charges from payment processors.
In 2022, a lengthy, landmark antitrust US lawsuit between credit card networks and retailers reached its conclusion. In the lawsuit, businesses argued that interchange fees (or swipe fees) charged by major card networks like Visa and Mastercard were too excessive. These fees hurt businesses as they had to pay more to cover the costs of accepting credit card payments from their customers.
A $30 billion settlement—the biggest antitrust settlement in American history—was reached to compensate retailers. After this ruling, however, Mastercard went ahead and increased its assessment or network fee to 0.14% from 0.13% in April 2024. Hence, merchants are losing more money on card transactions.
One of the aims of the lawsuit was to cap interchange fees for five years. It did not stop card networks from changing other fees, like assessment fees. Visa too has adjusted various fees in April 2024, such as an increase in its Account Name Inquiry (ANI) fee. The company has also introduced Processing Integrity Fees. In the end, merchants who accept high volumes of Visa cards will see their credit card processing costs rise.
Who keeps the interchange fees?
Many merchants believe their merchant account provider keeps the interchange fees. However, the provider only serves as a conduit, passing the interchange fees to the card-issuing bank (or issuer).
Merchants pay a small network fee for each transaction. This charge is split between the provider’s markup and the credit card association. The retailer’s merchant services provider also assesses varied fees on a per-transaction and monthly basis.
Factors That Affect Interchange Rates
Each credit card transaction carries its own interchange rate. To arrive at this figure, the issuing bank considers varied factors that affect the transaction’s risk level.
One such factor is the merchant category code (MCC). MCCs are assigned based on the type of business, and different types of businesses have different levels of risk and average transaction sizes, which are reflected in their MCCs.
1. Credit card brand
Each major credit card association determines its own interchange fees. Therefore, accepting one card brand over another may result in higher merchant costs.
Acquiring banks pay interchange fees as part of their cost structure, which helps cover the issuing banks’ expenses in processing card transactions and provides an incentive for them to offer card acceptance services.
Specifically, American Express has frequently been criticized for assessing higher fees compared to Mastercard or Visa. However, American Express now offers a program that increases the ability of small businesses to accept the company’s cards.
American Express charges merchants a “discount rate” instead of an interchange fee. However, the two terms essentially mean the same thing.
2. Transaction category
Credit card associations further segment their interchange fees by business categories (or business types). Common business cardholder types include general merchandise, gas stations, and restaurants, among others.
As the Federal Reserve System states, transactions made via general-purpose prepaid cards have an exemption from interchange fee standards. This exemption applies even if a covered issuing bank distributes the prepaid cards.
3. Debit cards vs credit cards
Credit card interchange rates are approximately six times as high as debit card interchange rates. Debit card transactions are less complex to process and easier to approve. Funds are taken directly from the customer’s linked bank account, so debit card transactions receive a reduced interchange rate, resulting in a lower interchange fee.
Encouraging cash transactions can also help businesses reduce interchange fees, as cash transactions do not incur any interchange fees at all.
Conversely, credit card payments involve the card-issuing bank’s extension of credit to each customer. The bank also covers the cost of the in-process transaction. The customer must later repay the bank for the transaction cost. Most credit card transactions will be approved if they do not exceed the account’s credit limit.
However, continued increases in credit card fraud have spurred banks to implement more complex security protocols. These practices are designed to put a halt to fraudulent payment system transactions.
4. Type of card owner
Credit card associations assign different rate categories based on a card’s ownership. In this respect, individual consumers are treated differently than businesses and government agencies. The rate variations are generally based on the card owner’s ability to repay the purchase amount.
Using this rationale, a private company’s or government agency’s purchase is regarded as less risky than a typical consumer transaction. Therefore, business and agency purchases will carry lower rates.
5. Card-present vs card-not-present transactions
Merchants undertake increased risks when accepting card payments without seeing the actual card. These transactions also cause card-issuing banks to face a higher risk. Therefore, card-not-present transactions are charged a higher interchange rate (and thus higher interchange fees).
eCommerce sales, along with telephone and mail order transactions, are considered card-not-present transactions. In a retail environment, this term also applies to manually keyed-in sales.
To illustrate, assume a card reader cannot recognize a worn-out magstripe card. Therefore, the sales associate must key in the numbers by hand. Fortunately, the widespread use of embedded-chip EMV cards greatly reduces the chances of this occurrence.
6. Address Verification Service (AVS)
During card-not-present transactions, the payment processor contacts the Address Verification Service (AVS) to confirm that the customer’s billing address matches the one on file with the issuing bank. Although payment processors typically charge a fee for this service, the resulting interchange rate savings often exceed the cost of the AVS fee, making it a financially beneficial process for merchants.
7. Transaction tokenization
Merchants who tokenize their customers’ transactions may be charged lower interchange rates. To illustrate, in October 2021, Visa began offering reduced rates to merchants who tokenize their card transactions. Tokenization has been recognized as an effective way to improve transaction security.
8. Rewards cards usage
Many issuing banks offer rewards cards for rewards programs that contain perks such as cashback on purchases or frequent flier miles. When a customer uses one of these types of cards, the merchant pays a higher interchange rate on that transaction.
Retailers who use a tiered pricing plan will be especially hard hit by rewards cards transactions. A tiered plan frequently downgrades these sales to “non-qualified” status. This downgrade results in rates that are two to three times higher than “qualified” transaction rates.
How Interchange Rates Are Calculated
Each country’s interchange rates can vary, and merchants in the US generally pay the highest rates. The process of calculating interchange fees involves determining the rate percentage and applying a specific calculation formula. Although competition among credit card associations has helped to minimize rate increases, rates have continued to rise.
Each credit card association uses its own rate percentage and calculation formula. The term “interchange qualification” refers to the categorization of a transaction to obtain its applicable rate.
To illustrate, Visa’s interchange qualification process integrates its Custom Payment Service (or CPS) into the mix. If a retailer follows specific rules, transactions can be re-qualified to a lower-rate interchange category.
Merchants’ Experiences with Interchange Fees
Every payment processor chooses its own payment processing structure. So, each framework treats interchange fees differently.
Interchange fees affect businesses that heavily rely on card transactions by impacting their operating costs, pricing decisions, cash flow, business model, and the choice of payment processor.
Interchange-plus and membership plans
The interchange-plus and membership-based payment processing plans separate the interchange and markup portions of each transaction fee. Therefore, the merchant can determine its processor’s portion even if the interchange rate information is unavailable. An established business with a predictable monthly processing volume will generally see savings with this model.
Flat-rate and tiered plans
These payment processing pricing plans blend the interchange and processor’s markup components into one fee. Therefore, it is virtually impossible for the merchant to determine the issuing bank’s and processor’s respective charges. Although this method makes it easier to predict transaction processing costs, merchants often pay higher fees overall.
However, flat-rate (or flat fee) pricing can be a good option for small businesses or seasonal merchants. Their payment processors do not typically charge monthly or annual account maintenance fees.
How to Minimize Interchange Fees
Smaller retailers can take several steps to reduce interchange fees. Various strategies for businesses to reduce interchange fees include negotiating with payment processors, choosing the right payment processor, improving card processing practices, and regularly reviewing processing statements. Some tactics pertain to the purchase transaction while others relate to retail services. Let’s take a look at some of them:
- Include order number and authorization ID at settlement
- Use the Address Verification Service for every transaction
- Settle transaction within three days of purchase
- Ship orders within seven days after authorization
It is important to balance financial returns with the optimal customer experience when reducing interchange fees.
Finally, merchants can minimize interchange fees by avoiding chargebacks. An excessive number of chargebacks might force a merchant into the “high-risk” group. This results in higher interchange rates and possible account termination.
Making the Best Choice
Every small- and medium-sized business wants to obtain the best credit card processing rates. Payment Depot streamlines your credit card transactions by equipping you with the latest payment technologies and terminals. Plus, with Payment Depot, you won’t encounter hidden fees thanks to our transparent, interchange-plus pricing model, ensuring you always know what you’re being charged. Contact us to get started today.
FAQs about Interchange Fees
Q: What are interchange fees?
Interchange fees are transaction fees that a merchant’s bank account must pay every time a credit or debit card transaction occurs. They cover the costs associated with processing the transaction and the associated fraud risks.
Q: How are interchange fees calculated?
Interchange fees are calculated by applying a specific interchange rate, or percentage, to the purchase total made on a credit or debit card. The specific rate depends on multiple categories and eligibility requirements associated with the particular credit or debit card in use.
Q: Who receives the interchange fees?
Interchange fees are paid to the card-issuing banks by the merchant’s bank, also known as the acquiring bank. The merchant’s account provider simply serves as a conduit for these fees.
Q: What is the typical range for interchange fees?
For credit cards, interchange fees usually range between 1.5% and 3.3% on average. For debit cards, interchange rates are approximately six times lower due to their relatively simpler transactional nature and hence, lower risk.
Q: What is the Durbin Amendment in relation to interchange fees?
The Durbin Amendment is a component of the Dodd-Frank Wall Street Reform and Consumer Protection Act that imposes a cap on debit card transaction fees. Introduced by US Senator Richard J. Durbin in 2010, this amendment reduced the previously average interchange fees from around $0.44 per transaction to $0.21 per transaction plus 0.05% of the transaction amount.
Q: Are interchange fees regulated?
Interchange fees in the United States are governed by regulations such as the Durbin Amendment. However, credit card associations such as Visa, Mastercard, American Express, and Discover independently determine their respective interchange fees.
Q: How can businesses minimize their interchange fees?
Businesses can minimize interchange fees by optimizing their transaction process, such as utilizing the Address Verification Service for each transaction, settling transactions as soon as possible, avoiding chargebacks, and using tokenization for transaction security. They may also choose to work with a trusted merchant service provider that offers competitive rates.
Q: Do interchange fees differ in various regions?
Interchange rates may vary from one country to another. Generally, merchants in the US pay the highest rates, while in Europe, the rates average around 0.3-0.4% of the transaction amount.
Q: Are interchange fees subject to change?
Some major card networks review their interchange fees annually. This could result in some rate increases along with rate reductions.
Q: What factors affect an interchange fee’s rate?
An interchange fee’s rate can be influenced by multiple factors, such as the transaction’s risk level, the card’s ownership and usage, the nature of the transaction (i.e., card-present or card-not-present), and the type of card (credit or debit).
