What is an interchange rate and how is it calculated?

Tilly Michell6 minutes
What is an interchange rate and how is it calculated?
In this article

Interchange rates affect all types of businesses that make card transactions in-store or accept card payments from customers, meaning they play a critical role in the financial ecosystem. 

In the long run, if you’re a business finance professional, understanding what interchange rates are, how they’re calculated and why your business has to pay interchange fees will put you in good stead when it comes to knowing how card transactions will affect your business. Keeping on top of interchange rates and fee changes will also ensure you can conduct the financial planning needed to secure your business’s future. 

In this article, we’ll walk you through what interchange rates are, how they’re determined, navigating the landscape of interchange fees, strategies for managing these costs, and the regulatory landscape and its impact on interchange rates. 

What are interchange fees?

Every time a card transaction is made with your business, the acquiring financial institution (or merchant acquirer) will pay a small percentage of that transaction to the cardholder’s bank as an ‘interchange fee’. Your business then pays the interchange fee back to the acquirer as part of its card processing fees. 

Interchange fees cover things like handling costs, coverage in the risk of fraudulent activity, the costs that come with bad debts and the risk that comes with approving the payment. 

Payment card processing comes with three kinds of fees, so let’s see where interchange fees fit within this.

  • Acquirer markup: Fees charged by your acquirer for acquiring the funds from your shopper and processing these funds.

  • Card scheme fees: Fees charged by the card scheme, for example, Visa or Mastercard, for using its network.

  • Interchange fees: Fees charged by the cardholder’s bank (the issuing bank).

The total of these fees is sometimes called the Merchant Discount Rate (MDR). Interchange fees make up the most significant chunk of card processing fees, estimated to be around 70 to 90% of the total fee amount.

Why are there interchange fees?

Card transactions simply wouldn’t be possible without interchange fees. They cover the risk taken on by the issuing bank in providing the customer with their credit card or debit card, and the cost of performing the checks needed to verify the payment. The interchange fee is the small cut the issuing bank takes to ensure it can continue to provide you, the seller, with the support needed to successfully receive funds from your customers, and your customers with the means to pay you. 

Decoding the cost: How interchange fees are determined

Interchange fees are set by card networks such as Visa and Mastercard. Interchange rates are regularly adjusted due to the fluctuating costs of moving money, the time value of money in terms of current interest rates, and the changing risk involved in making these transactions. For example, Mastercard and Visa usually change their rates twice every year in April and October. 

Interchange fees are determined by many different complicated variables. To simplify the fees so merchants can understand the formula, credit card companies usually offer interchange fees as a flat rate plus a percentage of the sales total (including taxes). In the US, the average rate is about 2% of the purchase amount per transaction. 

Let’s decode the cost of interchange fees by looking at the different factors that influence how they’re determined. 

Credit cards versus debit cards

Credit cards have higher interchange rates than immediate debit and prepaid cards, as there is a higher level of risk for the issuing bank in letting your customers purchase with them. 

Card schemes

Your customers will be charged a different interchange rate depending on the card scheme they’re using, for example, Visa, Mastercard or American Express. 

Card-present versus card-not-present

Card-present (CP) transactions (where the customers can actually present their physical card) have lower interchange rates than card-not-present (CNP) transactions. This is because the risk of fraud is lower when the customer’s card is physically present. Examples of CNP transactions include online payments and in-app payments. CNP transactions are a common target for card fraud, because it is difficult for the merchant to verify that it is the actual cardholder making the purchase.

Consumer cards versus commercial cards

If your customers are using commercial cards, they’ll be charged a higher interchange fee than if they were using a card designed for an individual. 

Where the transaction is taking place (transaction regionality)

If the card-issuing bank is in the same country as where the transaction is taking place, there will be a cheaper interchange rate than if it were a cross-border transaction. 

For international transactions, businesses should be aware of additional foreign exchange (FX) charges when collecting payments from overseas customers. Some payment processors charge upwards of 2% per transaction for currency conversion. 

Explore Airwallex Payments to see how you can enjoy more cost-effective global payment acceptance. Collect multiple currencies directly into your multi-currency account without being subject to unnecessary currency conversions, and save a significant amount on each international transaction. 

Merchant category code (MCC)

Your business’s assigned merchant category code (MCC) can also affect the interchange rate you pay. For example, if you’re a business providing utilities, a travel agent, a streaming service or charity, you may be granted a lower interchange rate in Australia and the US by Visa and Mastercard, in comparison to businesses who don’t fall into these categories.  

Interchange rates can be complicated to understand, and their level of impact can vary significantly based on the nature of the transaction they’re being applied to. This is particularly the case when it comes to card-present (CP) and card-not-present (CNP) scenarios.

Card-present transactions

In CP transactions, where the physical card is used for payment (such in-store purchases), interchange fees are typically lower. This is because the risk of fraud is generally lower when the cardholder (and their card) is physically present. The presence of EMV chips and PIN verification procedures also helps to reduce fraud in these scenarios.

Also, there's a higher likelihood of additional sales through CP transactions, as the purchaser is physically in the store so could buy items on impulse or agree to upselling. Depending on the extra amount they spend, this could potentially offset the cost of interchange fees for your business. 

Card-not-present transactions

On the other hand, in card-not-present transactions (such as online or phone purchases), interchange fees can be higher. This is because the absence of a physical card increases the risk of fraud, leading to the issuing bank charging higher fees to cover their potential losses.

Additionally in CNP transactions, there might be a higher rate of chargebacks or refund requests due to issues with deliveries or customers claiming they were unauthorised transactions, which can further impact the overall cost for your business.

What does this mean for different business models and industries?

Interchange fee impact varies between business models. Businesses that rely heavily on online sales may find CNP fees a significant cost factor that affects their bottom line. And on the other hand, brick-and-mortar stores might find CP fees slightly more manageable due to lower interchange rates and the potential for increased in-store sales.

Strategies for managing interchange costs

Making sure your business is minimising interchange costs and optimising your payment processes is crucial for improving your bottom line. Here are some practical tips for improving your business’s financial ecosystem, particularly related to interchange fees and payment processing. 

1. Negotiate terms with your payment processor

You can always give this a shot, however your business would need to process a lot of transactions in order to make the lower rate worthwhile for your payment processor. Businesses can also find a rate that’s right for them by shopping around for a cost-effective payment processor. 

2. Choose the right payment processing solution

Airwallex offers cost-effective payment processing on domestic and cross-border payments that can help you lower your interchange fees and maximise your conversions. Airwallex also offers adaptive success rate optimisation to help you improve payment acceptance rates, and a host of security features, including 3D Secure 2, to help you reduce the risk of fraud and chargebacks. 

3. Improve your payment practices

Settle your transactions quickly to avoid downgrades that result in higher interchange fees. Whenever possible, aim for same-day or next-day settlements. Make sure your accounting team is paying attention to providing accurate and complete transaction data, as inaccurate or incomplete data can lead to higher fees.

4. Review your statements regularly and make periodic adjustments to your strategy

Have your accounts team regularly review your merchant statements to find any unnecessary fees or errors, as catching these could save you significant costs. As well as this, make time to regularly reassess your payment strategy. As your business grows or market conditions change, there may be new opportunities to optimise your payment processes and reduce interchange costs. You can contact our experts at Airwallex for more insights and personalised advice.

Comparing pricing models in payment processing

Two common payment processing pricing models are Interchange++ and Blended pricing. Whether you choose Interchange++, Blended pricing or another pricing model will depend on your business's transaction volume, card mix, and the level of detail and control you desire over understanding your payment processing costs.

Interchange++ pricing

This model breaks down the costs associated with payment processing into three main parts:

  • Acquirer markup: Fees charged by your acquirer for acquiring the funds from your shopper and processing these funds

  • Card scheme fees: Fees charged by the card scheme, for example, Visa or Mastercard, for using its network or the software the card operates on

  • Interchange fees: Fees charged by the cardholder’s bank

Benefits of Interchange++ pricing

  • Transparency: You’ll get a clear view of your interchange fees and processor fees, meaning you can see the true cost of each transaction made with your business.

  • Customisation: Allows you to see which card types or transactions are more expensive and adjust strategies accordingly.

  • Potential for Cost Savings: Depending on the negotiation with the processor, businesses can potentially save money by having more control over the components of the fees.

Blended pricing

Blended pricing, sometimes called 'flat rate pricing', simplifies the fee structure by bundling all the fees into one rate. A single flat rate is charged for all transactions, irrespective of factors such as card type. That said, there will still be some fee variation for factors such as domestic payments versus cross-border payments.

Benefits of Blended pricing

  • Easy to understand: Since there's only one rate applied to all transactions, Blended pricing can simplify your business’s accounting and financial planning.

  • Predictable pricing outcomes: You’ll have a consistent rate for all transactions, making it easier to predict your costs.

Making the right decision for your business

While Blended pricing does simplify things, it might not be the most cost-effective option if your business deals with a wide range of card types (debit, credit, rewards cards and company cards) and transaction volumes. 

If this is the case, Interchange++ might offer you more control and potential savings when it comes to your business transactions. Interchange++ can also allow you to tailor your payment processing strategy based on card transaction types.

Get in touch with the team at Airwallex for more insights and personalised advice on which may be right for you.

The regulatory landscape and its impact on interchange fees

Interchange fee regulations vary significantly across different regions and countries, but some key elements commonly seen around the globe include anti-trust and competition laws, transparency requirements, interchange fee caps, consumer protection measures and frameworks ensuring fair access to payment networks for various market participants.

Overall, there's a growing recognition that transparent and fair interchange fee structures benefit everyone involved - businesses such as yourself, consumers, and issuing banks. This has been pushed by regulatory oversight, antitrust authorities, merchant advocacy and advancements in payment processing technologies. These changes allow you to better understand your costs, empower consumers to make informed choices, foster competition among payment providers, and contribute to a healthier and more balanced financial ecosystem.

Cost-effective payment processing

Interchange fees are key parts of the financial ecosystem, forming a core part of all card transactions, having significant impact on business bottom lines, and also influencing consumer spending and purchasing behaviour. For anyone involved in managing finances for any kind of business, it’s important to stay informed and make educated decisions when it comes to your payment processing strategies. 

If you want to optimise how your business handles card transactions, explore Airwallex’s cost-effective domestic and global payment processing technology. Airwallex makes it easy for you to securely accept payments from customers around the world, while saving on unnecessary fees. Integrate with popular global eCommerce platforms such as Shopify and WooCommerce, or configure and share your own Payment Links. Sign up today or contact our team to learn more.

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Tilly Michell
Content Marketing Manager

Tilly manages the content strategy for Airwallex. She specialises in content that supports businesses in their growth trajectory.

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