The Role of Interchange in Credit Card Transactions

The Role of Interchange in Credit Card Transactions

Interchange represents a fee paid by a merchant’s acquiring bank to a credit card holder’s issuing bank as component of the normal electronic payment process. The origin of interchange can be traced back to the practice of having merchants compensate card-issuing banks for lost interest brought about by cardholders taking advantage of their credit card bill grace period. The credit card processing industry characterizes the role of interchange as a means of maintaining an equitable balance of incentives between the credit card holder’s bank (the issuing bank), and the retail merchant’s bank that processes the transaction.

Interchange enables merchants to enjoy the benefits that come with credit card acceptance. These benefits include security in the form of fraud protection, guaranteed payment and speedy remittance of funds. Today, retail merchants are able to negotiate credit card acceptance costs with their acquiring banks, while merchant’s banks are likewise able to negotiate their costs with credit card issuing banks. This ability to negotiate costs helps keep the balance of incentives intact, but it often creates “friction” and inefficiencies within the system. To offset these inefficiencies, the credit card processing industry sets “default” interchange rates for use in the absence of formally negotiated processing arrangements. For the purposes of transparency, the industry may disclose default interchange rates on publicly available websites.

The Credit Card Payment Process

Whenever a credit card transaction occurs, the cardholder’s bank pays the retail merchant’s bank for their cardholder’s purchase minus the interchange fee. The merchant’s bank then pays the merchant from what remains minus a markup for the financial service of credit card processing, merchant accounts processing. The merchant ultimately receives an amount of money equal to the sale price of the item plus the sales tax minus a series of fees and markups that include interchange fees and other costs. Interchange represents the largest component of all the various fees that merchants can pay for the liquidity and privileges provided by credit card processing, merchant accounts. Interchange fees are non-standard. They will vary according to what category any individual credit card transaction can be placed in. Different factors determine how credit card transactions are categorized.

Some of the factors relied upon to categorize credit card transactions are under the control of the retail merchant and some are not. Such factors include the processing method — was the charge card present at the time of the sale? The interchange “card present” category is assigned a lesser fee than the “card-not-present” category. Other factors influencing interchange categories and fees include card type (debit or credit), card brand and how cardholder data is captured.

The process of analyzing and adapting a merchant’s processing polices as a means to incur the lowest interchange costs is known as “interchange optimization.” Since interchange costs account for the bulk of a merchant’s card processing overhead, ensuring that the maximum number of credit card transactions qualify for the lowest-cost categories as often as possible is a good way for retail merchants to fatten their bottom lines.

Per Transaction Charge in the Credit Card Processing Industry

When running a business and looking for a credit card processing service, many business owners make the mistake of focusing on processing rates instead of per transaction fees. These are the two main types of fees that credit card processing services charge, and there is a reason why both are applied to purchases.

The processing rate is a single percentage that the card processing service makes off of the total volume of a transaction. The per transaction fee is a flat rate that is charged every time a transaction is completed. This often ends up costing more than the actual processing rate, especially for merchant accounts that have a low sale amount per transaction. So why are there per transaction charges in the card processing industry? This is how card processing services make most of their money.

It is important to understand that the per transaction fee is widely misunderstood. When people think of per transaction fees, they picture the flat fee they are charged every time company uses that service to run a transaction. Return fees, authorization transaction  fees and even AVS fees are other examples of per transaction fees.

It would be unfair for processing services to charge a flat rate for their service since some business process credit cards less frequently than others. It is simply a better business practice for the processing service to charge on a per transaction basis.

When using the same provider, every business pays the same in per transaction fees. It doesn’t matter if the merchant accounts are national chains or mom-and-pop stores. Every company that takes credit cards as a form of payment is hit with the per transaction charge, and the amount of this charge stays the same no matter what.

For example, a customer may walk into a chain shopping center and leave with a dinning room table. At a local store, the customer may buy a pack of gum. Despite the total of each purchase, both stores are charged the same per transaction fee. So, when companies are looking for a credit card processing service, they should focus a little less on the processing rate and more on the per transaction fee that the service charges.

Why Some Credit Cards Cost You More to Process Than Others

Credit card processing statements are difficult to understand due to the number of different rate categories listed on the statement. In fact, different merchant account fees charged by a credit card processor for merchant accounts can make it difficult for business owners to understand what they are paying to accept credit cards. Though it may seem like every transaction should be charged the same amount, there are a number of reasons for the costs of credit card transactions to vary from one transaction to another. In order to choose which processing plan is best and save the most money, business owners need to understand the basics of processing charges including why some credit card transactions cost more than others to process.

Interchange Fees

Interchange fees are charges that the banks charge for credit card processing. Banks typically charge both a flat fee and a percentage of the transaction. For example a bank may charge 10 cents per transaction and 1% of the total transaction. Each type of card (Visa, MasterCard, etc.) sets their own rates and the rates will actually vary on the same card depending on a number of factors. For example, a credit card issuer may charge different rates for the purchases of different types of products and for different types of cards. All of these different factors mean that one type of card may charge a business a larger amount for a transaction than another.

Markup Fees

Every credit card processor charges a markup above the interchange fee. This markup is used to pay the costs of the transaction for the processor as well as to create a profit for the processor. In general, the markup fee is based on a percentage of the interchange fee, but the fee can be calculated in different ways. When the fee is based on the interchange fee, the markup fee will vary from one card transaction to another along with the different interchange fees charged by the card issuer.

If the differences between the fees charged for different credit cards are not enough to confuse those trying to understand the fees on merchant accounts, the fee structure for debit cards also varies. Debit card fees are typically slightly less than the fee charged for credit card transactions. However, the fee that a business will be charged for a debit card transaction will vary depending on factors such as whether or not the charge was a PIN based transaction.

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