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What are interchange fees and how are they calculated?

Definition: Interchange fees are transaction fees that the merchant's bank account must pay whenever a customer uses a credit/debit card to make a purchase from their store. The fees are paid to the card-issuing bank to cover handling costs, fraud and bad debt costs and the risk involved in approving the payment.

How are interchange fees charged to businesses?

Card-issuing banks, payment processors (which may or may not be the issuing bank), credit card payment networks like MasterCard and Visa, payment gateways, and the merchant's own bank will all charge a percentage-based fee on every transaction, and these charges frequently appear as a single, bundled amount on the bills your payment processor hands you. Even this is something of an oversimplification, however, since there are actually about 300 individual interchange fees composing the "single" interchange fee you actually pay.

Interchange fees are not static

Based on the costs of moving money, the time value of money in terms of current interest rates, and the relative risk involved, credit card companies set and regularly adjust their interchange rates. Visa and Mastercard, for example, change rates twice a year, in April and October. While there are other fees that merchants pay for the privilege of making sales via credit and debit card, interchange fees are by far the largest, representing 70% to 90% of the total fees paid to banks by merchants.

How interchange fees are calculated

Interchange fees are determined by a large number of complex variables. To simplify the cost for merchants, credit card companies compute interchange into flat rate plus a percentage of the sales total (including taxes). In the U.S. alone, billions of dollars are paid out by merchants to cover these fees every year, with the average rate coming out to about 2% of the purchase amount.

Transactional factors affecting interchange

  • **Card type:**Debit cards with PINs have lower rates than credit cards due to lower risk, and each credit card company will charge a different rate. Rewards cards pay for the perks given to card holders by charging higher interchange rates to businesses. The perks may, however, induce consumers to purchase more.

  • **Business size and industry:**Rates can vary by business type — supermarkets, for example, pay more than do gas stations. Additionally, larger merchants often have lower rates because they have enough "clout" to successfully negotiate with banks/credit card companies.

  • Transaction type: POS (point-of-sale) transactions are less risky than CNP (card-not-present) since the chip can be scanned, a signature taken or a PIN entered. Both MOTO (mail-order-telephone-order) and online orders are classed as CNP and charged a higher interchange rate.

Interchange fees are a part of doing business

Any business that allows customers to make purchases with credit/debit cards will have to pay interchange fees. While no online retailer likes to see potential profits deducted from a sale, the net gain from accepting credit/debit cards far outweighs the cost of interchange fees.

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