When you, as a merchant, accept a credit or debit card, you have to pay a number of fees. These fees usually come in three categories that benefit different parties providing the service:
- Processing fee — charged by the payment provider
- Card scheme fee — charged by the card schemes (Visa/MasterCard/American Express)
- Interchange fee — charged by the cardholder’s bank
In this post, we will take a closer look at the last category, interchange fees or interchange reimbursement fees. These are charged by all card schemes, but take note that while Visa and MasterCard both refer to them as “interchange fees”, American Express refers to them as a “discount rate”. Nonetheless, both are essentially the same charge. Interchange fees are paid by you, the merchant, or any entity that accepts credit or debit card payments. They are calculated per-swipe, as in every time that a credit or debit card is used.
Historically, the fee was justified by banks as a compensation for them handling the risk of accepting customer credit, as well as a way to make up for charges inherent in card transactions. The banks used this fee to reimburse any lost interest from cardholders repaying their debt. Nowadays, the justification is not as clear cut. On Visa’s official website it states that “Visa uses interchange reimbursement fees as transfer fees between acquiring banks and issuing banks for each Visa card transaction. Visa uses these fees to balance and grow the payment system for the benefit of all participants.” As you can see, the specific rationale behind these charges (especially as opposed to processing and other existing fees) is not clear.
The process of how interchange fees work is as follows:
- You accept a credit or debit card.
2. The issuing bank (the cardholder’s bank) withdraws the money from the cardholder’s account.
3. The issuing bank deducts interchange fees from the amount withdrawn and keeps them as its fee plus any markup.
4. The issuing bank deposits the difference into the acquiring bank (your bank).
5. The acquiring bank charges you the difference between the original amount withdrawn and the amount that was deposited by the issuing bank plus a markup.
This means that the interchange fee is paid by the acquiring bank to the issuing bank, and then the acquiring bank charges you the cost of those fees plus potential interest. The amount you pay is referred to as a “merchant discount” to your financial institution. It’s common both for the acquiring bank to charge extra interest and for the processor to “pad” interchange fees by adding to the fee without informing you. Because there are very few regulations in credit card processing in the US, both markups are legal.
Interchange fees change biannually, in April and October. They are decided by the card schemes themselves, so Visa, MasterCard, and Amex all decide what to charge, even though the money is paid to banks. The specific fees vary based on transaction type, location, sales channel, and business model. For American Express the fee is calculated based only on the type of business being charged. Usually the fee cannot be changed, although larger companies can supposedly negotiate with Visa and MasterCard for lower rates.
Different card types get charged different rates. In general, debit cards have significantly lower fees as compared with credit cards. Additionally, high-end reward credit cards usually have higher fees as compared to non-reward cards. The fees also change depending on the processing method used. The method can be either card-present or card-not-present. Card-present methods get charged lower fees. These methods are when a card is used directly, such as swiping, using a chip, or tapping with contactless payment methods. Card-not-present methods are usually those where you have to enter card details manually into a machine or online portal, such as with online checkout systems or invoices.
The fee itself is usually charged as a flat fee plus a percentage of the transaction value. Debit cards have standard fees of 0.05% + $0.21. On the other hand, credit in the US is unregulated, so the fees vary wildly. As of September 2020, the fees for Visa vary from 0.8–2.95% and $0.04–0.20 flat fee. For MasterCard the fee varies from 0.19–3.25% and $0.05–0.10 flat fee.
Overall, interchange fees can be a pretty significant part of your expenses, especially if you operate a low margin business. However, if you want to accept credit or debit there is nothing you can do, especially because you can’t fully control what kinds of cards your customers use and thus what kinds of fees you will be charged.