The Truth About Interchange

November 27, 2020

Interchange fees make up the largest portion of a merchant's payment processing costs, however, it is often not clear what these fees are and how they are charged. In some cases, processors can contribute to this lack of clarity to make their quotes seem superior. In this article, we will break down interchange fees to leave you with a clearer understanding of what interchange is, how it works, and what you should look out for.

What are interchange fees?

Interchange Reimbursement Fees, commonly known as interchange fees or abbreviated as IC, are a type of transaction fee charged by the card brands and passed through acquiring banks whenever a credit or debit card transaction is made. When a card transaction occurs, the card brands (Mastercard, Visa, Discover, American Express, etc.) charge the acquirer (the processor) a fee for the transaction in order to cover expenses such as handling costs, fraud protection, potential risk, as well as for the use of their settlement networks. The acquirer will initially bear these costs on behalf of its merchant and will then charge these fees on the monthly statement as part of the merchant’s regular transaction expense. Sometimes, interchange fees will be bundled under tiered or flat rates that include other fees and the processor’s mark-up or profit. In other cases, the various interchange categories are listed individually on the statement, along with their costs, and a separate discount fee is added above that to cover additional processor expenses and allow for profit.

How are interchange fees determined?

Interchange fees are determined based on interchange rates, which are set by the card brand companies (i.e. Visa, MasterCard, Discover, and American Express). These rates are published in interchange fee tables, which for Visa and MasterCard, are revised twice a year, typically in April and October. Each card brand sets its own interchange rates, which are in the form of a percentage of the transaction, plus a flat per item charge. For example, if the interchange rate for a transaction is 1.5% + $0.10, then for a $10 transaction, this would amount to $0.15 + $0.10 = $0.25.

What factors affect interchange rates?

The interchange rate category a transaction falls under will vary based on a number of factors, such as:

  • Merchant’s Business Type: Based on the merchant’s business type/industry, a Merchant Category Code (MCC) will be assigned. The interchange category that a transaction falls under is impacted by the MCC, and MCC's with larger potential risk (such as casinos) will receive higher interchange rates. For some business categories such as Retail and Supermarkets, interchange categories may be split into different tiers based on certain threshold criteria such as the number of transactions, total transaction volume, and compliance with PCI-DSS.
  • Card Type: Interchange rates are set by the card brands, and so interchange rates and categories will vary between the different card brands. Within a single card brand, rates will also differ by card type, for instance, credit cards have higher rates than debit cards due to the larger risk credit card transactions carry, and rewards cards often have higher interchange rates due to the additional perks they offer. Card ownership also comes into play here, with corporate or government cards falling into different interchange categories as compared to consumer cards,  primarily due to the additional services available to those ownership types.
  • Transaction Method: Transactions made in person (card present) are deemed less risky than CNP (card-not-present) transactions (such as payments made online or via the phone), as the card data can be captured directly instead of being manually entered. As a result, interchange rates for CNP transactions are priced higher than card-present transactions.

The combination of factors discussed above determines the specific interchange category for every single card transaction processed by any merchant for any cardholder.  To put it in perspective, the least expensive transaction to process is one made in person, at a grocery store, with a debit card because grocery purchases present very little risk.  An example of a high cost transaction would be a phone payment for future travel reservations using a high value corporate card because greater services (rewards, special statements, etc.) are provided to that cardholder and payments for future travel are frequently canceled or charged back if there are problems.

What should I look out for?

As interchange rates are set by the card brands, this means that interchange fees must be charged based on the rates specified in the interchange fee tables. However, some payment processors have claimed to be able to offer lower interchange rates due to “special arrangements”, which by definition is not possible, as these rates are non-negotiable. While a merchant's total interchange costs can be lowered by adjusting how they accept payments in order to qualify for a lower-cost category, the interchange rates themselves are fixed and cannot be adjusted. Therefore, if a payment processor claims to be able to offer lower interchange rates, this is patently false.

Payment processors may also disguise additional mark-up fees as interchange fees, for example, if a fee is 1.5% + $0.10, they may display it on the merchant’s statement as 1.65% + $0.10, in order to disguise their own mark-up fees as part of the interchange fee. This practice is known as “padding”, which once again is something to look out for, as interchange rates should not differ from those set by the card brands. Every processor has access to the same interchange costs provided by the card brands, but since certain merchant category codes (MCCs) have lower interchange costs. As in all lines of business, there are “bad actors” among processors who can miscode merchants to try to achieve lower interchange rates, but these actions put the merchant at risk for fines and or account closures.

At Payscout, we strive for transparency in pricing and work with all our partners, agents, and merchants to provide the analysis, insight, and information necessary to fully understand interchange costs. Our understanding and expertise is your advantage. If you have any additional questions or concerns about interchange fees, please contact our team at sales@payscout.com for more information.

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