You are likely reading this because you have heard the term “interchange” but are unfamiliar with what it means for you and your business. In short, interchange is an underlying cost for a merchant that allows their customers to use credit cards to purchase their products and services.
Interchange is relatively complex, so this article will give you an overview of the concept to help you wrap your head around it. We will discuss what interchange is, why it exists, what interchange fees are, and what you can potentially do to lower your costs.
The term ‘Interchange’ is short for ‘interchange reimbursement fees.’ For ease of reading, we will merely use ‘interchange.’
Without further ado, let’s dive right in.
What is interchange?
In short, interchange is the mandatory fee you pay each time your business accepts a card transaction when purchases are made through your store. The fees associated with interchange are the primary costs you will pay to Visa or Mastercard. The majority of the fee will go to your issuing bank, and the remainder will go to the acquiring bank.
In other words, when a cardholder uses a credit card to purchase items or services, they have a grace period for paying off their debt. The cardholder’s bank then gives the funds to the business. The interchange is when the business reimburses the bank for lost interest on the amount.
Think of the interchange fee as a tax you must pay so consumers can enjoy the convenience of paying for your products and services with a credit or debit card.
Interchange determines the various ‘categories’ that banks use to decide on rates for each card transaction. Each category has multiple checkbox requirements that, once met, incur a fee (a percentage, and sometimes a flat fee on top). The fees are for credit card processing—the costs incurred from transactions, plus a bit extra so the banks can make money.
The fee has three components:
- Interchange
- Assessments
- Processor makeup
For brevity, we will not discuss the second and third components of the fee. Either way, interchange is the most significant part of the three components. The amount a merchant must pay is already determined, and it is final (non-negotiable). The merchant pays the fee to the customer’s card-issuing banks. There’s no point in working up a sweat by trying to lower these fees, and they are non-negotiable and set by Visa and Mastercard themselves. Be aware that Mastercard and Visa change their fees twice a year—in April and October—so be sure to stay on top of any changes.
The categories mentioned above are numerous. Both Visa and Mastercard have “fee tables” that let merchants know how much they need to pay in fees each time they meet a category’s requirements.
The ins and outs of interchange fees
As discussed, interchange fees are how much a merchant has to pay by the percentage of a transaction based on the interchange categories. The categories are complex, and each one has exacting requirements. Each time a transaction meets the category’s requirements, the merchant will be charged that particular interchange fee.
But all fees are different, and you could be paying a fee of as little as 0.050% (plus a small fee on top) or as high as 2.95%. Although Visa and Mastercard are transparent about their fees, not all companies are. For example, both Discover and American Express keep their interchange schedules hidden, and American Express calls their interchange fees “discount fees.”
Interchange fees are paid solely by the merchant to the processor to accept credit cards. However, the fees a merchant pays aren’t paid directly. First, the acquiring bank pays the fees, and the merchant the acquiring bank back.
Think of it like this: when a merchant first accepts a payment, the money doesn't leave the customer’s account straight away. So what a merchant gets is a deposit of the funds from their acquiring bank. The issuing bank (the cardholder’s bank) takes the money from the customer’s account and subtracts the interchange fees before giving it over to the acquiring bank. The acquiring bank then charges the merchant because otherwise, they would have lost money from the transaction. Therefore, they charge the difference from the original transaction, and they put a markup on it to make a profit.
The bank is looking to recuperate the costs they incur (plus some extra) due to the transaction, hence the fee.
Can I do anything about interchange?
It is quite complicated to answer this question, but the answer is yes and no. Although interchange fees are mandatory and, as previously mentioned, non-negotiable, there are methods you can utilize to reduce them. The practice of reducing your fees as much as possible is called ‘interchange optimization.’ This process is not simple, and if you find yourself confused, we do not blame you. Feel free to reach out to an L3 representative if you would like guidance. But let’s explore some of what you can do yourself.
First, understand that interchange fees are a cost and are determined on many factors that are outside of your control. Examples of this include the type of credit card the customer uses at the checkout (for example, a Business Rewards card will have a higher cost than a standard credit card or debit card), and how the card is accepted (over the internet, at a terminal, etc.). Therefore, it is essential to understand that costs shift across different transactions, even if the payment is the same amount for the customer.
Remember that each transaction will slot into various interchange categories, which is contingent on several factors. Although you cannot lower your rates in a specific category, you can alter how you take credit cards or settle transactions so the transaction will qualify for a category that gives you a lower cost.
Know that the fees you pay for interchange comprise the most considerable amount of your business’s credit card processing expense. Therefore, it is fundamental to ensure your transactions are in the lowest categories as often as physically possible to achieve interchange optimization.
Is there anything else I should know about interchange fees?
If you think the seemingly small fees do not affect your business all that much, think again. They affect everyone: merchants, banks, and your overall income. If the fees were insignificant, why do you think you see shops that do not allow card transactions below $10? Because it can harm the merchant. Also, know that between 70% and 90% of what you pay to banks is likely through interchange fees. If that’s not a reason to seek out interchange optimization, I’m not sure what else will convince you: Oh, maybe that merchants pay billions of dollars worth of these fees each year.
Conclusion
Interchange may be a little confusing, but it’s always best to understand it as a business expense and strive to achieve interchange optimization.
If you have any further questions, please feel free to reach out to an L3 representative who will be more than happy to assist you.
