Credit and debit cards have become the preferred payment methods for many, and it isn’t hard to see why. This small rectangular piece of plastic enables customers to ditch bulky wads of cash, making payments easier and safer.
In 2023, 27% of all point-of-sale (POS) payments were made using credit cards while 23% were made with debit cards. A survey by Forbes Advisor also revealed that 33% of consumers prefer to use credit cards as they’re safer than carrying cash.
However, this convenience comes at a cost, mainly for businesses. Behind every seamless payment card transaction is a complex network of banks, credit card companies, and payment systems working together to transfer money from the customer to the merchant.
Maintaining this complex network requires funding—a lot of it—and this is where interchange fees come in. As such, interchange fees make up the bulk of the fees merchants pay to accept debit and credit cards. Because of this, it makes better business sense to understand how they are calculated.
TL;DR
- Interchange fees make up the bulk of the processing fees merchants pay to accept cards. Although they go to issuing banks, the rates are set by card networks.
- Apart from keeping complex payment structures running, interchange fees compensate issuing banks for taking on cardholder credit risk, and help card companies fund rewards programs.
- While interchange fees are non-negotiable, knowing the factors that govern them and how they are calculated, can help you employ suitable strategies to offset these costs.
What Are Interchange Fees?
Interchange fees (or swipe fees) might appear to be just a cost merchants pay to accept card payments. But there’s more to it.
Every time a customer makes a payment with a credit or debit card, the merchant’s acquiring bank pays a fee to the customer’s card issuing bank. Although these fees go to the issuing bank, the rates are set by card networks like Discover, American Express, Visa, and Mastercard.
They use complex calculations to come up with the rates, which may vary depending on the card network. Swipe fees also depend on a variety of factors that we’ll explore later in the article.
The interchange fee usually includes a percentage of the card transaction value and an additional fixed charge. Payment processors usually tack on additional fees on top of interchange to compensate for their services (based on their pricing model).
The Purpose of Interchange Fees
Now that you know how interchange fees work, let’s look at how they help. Apart from keeping complex payment structures running, interchange fees compensate issuing banks for absorbing risks associated with extending credit to cardholders. Credit card companies also use them to fund rewards programs.
Keep card networks up and running
Large, global infrastructures are required to process massive volumes of transactions safely and efficiently. Card networks must maintain them properly and pay for fraud prevention tech (data encryption, tokenization, real-time tracking, etc.).
Swipe fees fund these initiatives and cover the maintenance costs. To improve the payment experience for consumers, card networks must innovate and incorporate the latest technologies. Think AI-powered anti-fraud measures and contactless payments—such advancements are funded by interchange fees.
Encourage the use of credit and debit cards
About 80% of interchange fees go to issuing banks, which incentivizes them to encourage their customers to adopt debit and credit card payments. This is a win-win situation for issuing banks and credit card payment networks.
Issuing banks often use interchange fees to fund reward programs, encouraging more credit card usage. A 2024 survey found that earning rewards is the #1 reason people use credit cards.
Covers risk taken on by issuing banks
Issuing banks take on financial risks while extending credit to cardholders. This includes defaulted payments, operations risks, security breaches, and chargebacks. Interchange fees help mitigate the financial impact of these risks, ensuring cardholders can continue to access credit.
Key Factors That Determine Interchange Fees
Interchange fees aren’t one-size-fits-all. They depend on various factors. Card networks set their fees based on these variables to fund their goals.
Card type
Interchange fees differ not only by card networks but also by the type of payment cards used. Debit card interchange fees are lower than that of credit cards. This is because funds are pulled from the cardholder’s bank account, posing less risk for the issuing bank.
Cards with more features (premium cards, corporate cards, reward cards, etc.) have higher fees compared to basic payment cards. Cards that pose a greater risk to the issuer come with higher interchange fees.
Transaction type
Again, the larger the risk, the higher the interchange fee. Certain transactions, like card-not-present transactions, are riskier, so interchange fees will be higher in such cases. Transactions at points-of-sale where a customer physically swipes or inserts their card have lower interchange fees.
Security technology
Additional security measures like EMV chip cards and contactless payments can both influence interchange fees. Since EMV chip transactions are harder to counterfeit, they often come with lower fees than traditional magnetic stripe payments.
Similarly, contactless payments like tap-to-pay cards and mobile wallets qualify for lower fees when processed securely. If your business processes these payments with less secure methods, the interchange fee could increase.
Merchant Category Code (MCC)
Businesses are classified under different categories based on the types of services and products they sell. These categories reflect the levels of risk, transaction volumes, and other important details. Hence, your MCC code also influences the interchange fees you’ll have to pay.
Transaction size and volume
In most cases, a percentage of the overall transaction amount goes towards interchange fees. So in absolute terms, the larger the transaction, the more you pay in interchange fees.
To reiterate, the biggest factor that affects interchange fees is the card network. Card networks set rates based on the factors listed above and their business goals. Keep an eye out for interchange rates published by these payment networks, which usually happens in April and October every year.
How Interchange Fees Are Structured
Interchange fees are typically structured as a percentage of the transaction amount, a flat fee per transaction, or a combination of both. Card networks typically use a combination of both when setting interchange fees.
For example, a card issuer might charge 1.5% of the transaction value plus $0.10 per transaction. This structure ensures that credit card companies receive compensation for both high- and low-value transactions. Even for low-risk cards (e.g., debit cards), the interchange fee structure is usually a percentage of the transaction amount plus a fixed fee.
Payment processors set their own pricing models, which determine how interchange fees are passed on to merchants. Always read the details of these pricing models thoroughly before settling on a payment processor.
Here are a few examples of interchange fee structures:
- Visa credit card transactions – Standard rates hover around 1.80% + $0.10 per transaction.
- Premium or reward cards – These often have higher rates due to added benefits, so the interchange fee could be as high as 2.00% + $0.15 per transaction.
- Mastercard debit card transactions – Rates could be approximately 0.50% + $0.22 per transaction.
American Express is unique in the sense that it operates as a card network as well as an issuer and usually charges higher credit card interchange fees. Note that these examples simply illustrate what an interchange fee breakup looks like. The amount your business ends up paying could vary greatly as there are so many factors that affect these rates as mentioned earlier.
How Businesses Can Manage and Reduce Interchange Fees
Interchange fees can often make up about 90% of your credit and debit card transaction processing costs. According to data released by CMSPI, businesses ended up paying more than $220 billion in card processing fees in 2023.
Working on managing costs related to interchange fees can be beneficial for every business. While there’s no way to negotiate these fees with card networks, you can employ a few methods to offset these costs.
Choosing the right payment processor
Not all payment processors charge the same fees, so it’s important to compare pricing models. An interchange-plus pricing structure is often more transparent than flat-rate models, allowing businesses to see the exact interchange fees they’re paying. Some processors also offer lower rates for specific industries or transaction types.
Stax, for example, charges a monthly membership fee to process transactions regardless of how many transactions you process (within your applicable tier). Work with a payments processor that matches the needs, constraints, and goals of your business, thereby leading to reduced card processing costs.
Encouraging card-present transactions
As a business owner, if you want to reduce the costs of accepting payment cards, you should ensure transactions are as low-risk as possible. One way to do this is to encourage card-present transactions. Such transactions, especially those using EMV chips, have lower fraud risk, which often results in lower interchange rates. Train your employees on processing card payments correctly and invest in the latest card terminals.
Using level 2 and level 3 data for B2B transactions
If your business processes government or corporate cards, be prepared to provide level 2 and level 3 transaction data. This can significantly reduce the credit card interchange fees that you incur. Details like tax amounts, invoice numbers, and item descriptions help issuers verify transactions and reduce risk.
Negotiating better rates with providers
Although you can’t change interchange rates fixed by card networks, you can negotiate the rates your payment processor might charge you. Businesses that process high volumes of card transactions can work out better rates with their payment processors or acquiring banks.
Look for companies offering custom pricing models based on transaction size and sales volumes so that you can negotiate better rates as and when necessary. Regularly reviewing processing statements and discussing rate adjustments with your provider can help ensure you’re getting the best possible deal.
Understanding surcharge rules and cash discount programs
Surcharging is used by many businesses to pass on card processing fees to the customer or cardholder. There are strict regulations around surcharging so keep yourself informed to avoid facing hefty fines.
Surcharging can also lead to customers being dissatisfied with paying more for their card purchases. This can lead to lower sales if not managed and implemented properly. Alternatively, you could set up cash discount programs, encouraging customers to pay with cash by offering a small discount, reducing card processing costs altogether.
Final Words
Interchange fees make up a big part of your payment processing costs, so understanding them will help your business save money. Choosing the right processor, using lower-cost transaction methods, and reviewing fees regularly can all help in reducing costs. A smart payment strategy will keep transaction fees manageable while ensuring a smooth checkout experience for your customers.
To learn how you can offset your credit card processing costs with Stax, contact us today.
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