What are Interchange Fees and How It Impacts Merchants

As you’re making money, you’re spending money (in some cases being charged fees). That’s what happens when you process credit card transactions through your website. These fees are called interchange fees and depending on your setup, it can be a big deal or something you can easily manage.

It’s important to know what your interchange fees are, how they’re calculated, and the impact they can have on your business.

That’s exactly what this article focuses on – the most important things you need to know about interchange fees.

What are interchange fees?

Interchange fees are transaction fees that your bank account, as the merchant, is debited every time a customer makes a purchase with a credit or debit card in your store. This applies whether you have an online store or physical location.

These fees are paid to the customer’s bank – the issuing bank – to handle the transaction costs, as a hedge against bad debt, and other risks involved in credit card transactions. Your bank and credit card networks also collect a portion of the fee.

Many people don’t realize just how many institutions are involved in a single transaction. Each of them gets a piece of the interchange fee pie. Card creators like MasterCard and Visa, the issuing bank, and payment processors charge their own percentage.

When you, the merchant, is shown the bill for the interchange fee, everything is usually bundled together. Of course, this is a simplified version because I don’t want to mention the 100s of individual transactions that actually make up the interchange fee.

Interchange fees fluctuate

Just like the value of money, the interest rates, and other factors in the financial markets fluctuate – so do interchange fees. Visa and MasterCard adjust it every year in April and October. The rates can also vary widely between different card networks. Visa & MasterCard tend to have the cheapest fee while American Express has the most expensive.

It may also be different because of the nature of the card you use. Debit cards have lower interchange fees while credit cards have higher fees. Amongst credit cards, there’s usually a higher fee for rewards or premium cards.

If a card is used in person with a pin then the fee tends to be lower and if a transaction is made over the internet or phone then the fee is higher. There are many levels and permutations in the interchange fee which is why banks will usually lump everything together and present it as one fee.

How interchange fees get calculated

As I explained in the last section, there are a lot of factors that affect the amount you’ll pay per transaction. In order to make it easier for everyone involved, merchant banks calculate the number as a single percentage plus a fixed fee.

Online payment processors like Stripe and PayPal that double as your merchant account tend to have much higher fees than merchant accounts maintained by your bank. For example, with your bank, you can expect to pay around 2% +$0.10 per transaction.

With an online payment processor, that number is around 2.9% +$0.30 per transaction. A single percentage point and twenty cents per transaction seems like a small amount but 1% of a one hundred thousand dollars is $1,000. The more effective your marketing machine, the more money you’ll make which in turn increases the fees you pay.

Controversy around interchange fees

Originally, it was thought that interchange fees were implemented to maintain a healthy mix of issuers and acquirers in the card network scheme. Professor Adam Levitin of Georgetown University Law Center paints a different picture.

From his research, it was found that it was implemented by banks to avoid usury and Truth-in-Lending Laws.

In short, it’s a great way to make money for banks. Visa and MasterCard alone make tens of billions every year. Remember, they get the smallest percentage of every transaction. Banks rake in the rest.

Many organizations and regulators have questioned the validity of the fees being fixed in the way that they are. The actual cost of performing credit card transactions has gone down considerably but the interchange fees have been rising steadily over the last few years.

Another issue was raised by the Federal Reserve Bank of Boston. It performed a study, which you can find here, and found that low-income households transfer a portion of their wealth to high-income households through the interchange fees and rewards cards. It’s interesting to see the significant impact it can have over the course of years.

What can you do about your interchange fees?

As far as paying it or not, there’s nothing to be done about it if you want to continue accepting credit or debit card payments. It’s the system we find ourselves operating in.

With that being said you don’t have to accept the interchange fees you’re being presented while sitting on your hands.

What do I mean by that?

As I mentioned in this article, online payment processors like Stripe and PayPal charge considerably more than a merchant account set up through a bank. They’re aware of this but they’re hoping a lot of their customers aren’t.

Even if they’re aware, they’re hoping they don’t get worked up over it because it’s just 1%. When you’re doing a decent volume, that 1% adds up pretty quickly. Doing a lot of volume is also your key to getting a better interchange fee.

Once you’ve hit a certain level of success, your payment processor will take note and reach out to you to ensure you’re happy with their platform. Even if they don’t, you can be proactive about it and reach out. Request they give you better terms.

Even a half of a percentage point will make a huge difference over time. It may not work but the most important thing to do is ask.

Conclusion

Interchange fees are a normal part of business – especially online. Instead of looking for ways to beat them, accept them as a part of life.

Just because you accept it as a part of life doesn’t mean you can’ do anything about it. After all, rain is a part of life but we figured out umbrellas work well.

Likewise, you have some wiggle room in the interchange fee you pay.

If you process a considerable volume of transactions in your business, reach out to your merchant account holder and see if you can get your interchange fees reduced. Let me know what you think in the comments and don’t forget to share.