Interchange fees explained

What are interchange fees?

Interchange fees are transaction fees that merchants are charged when accepting card payments from customers, whether online or in-store. These fees are also known as 'swipe fees' and are set by credit card payment networks such as Visa, Mastercard, American Express, and Discover.

While many think of interchange as a single per-transaction fee, it consists of charges from:

• The card issuer: the customer’s bank or credit card company, also known as the issuing bank

• The payment network: credit card payment networks (e.g., Visa, Mastercard, Discover, American Express) that set card interchange fees and facilitate the transaction process

• The acquirer: the merchant’s bank or payment facilitator, also referred to as the acquiring bank

Interchange fees are charged based on various factors, including the type of card the customer uses, the country of card issuance, and whether the transaction occurs online or in person. Issuing banks and acquiring banks are both involved in processing payments and managing the flow of funds during card transactions.

Let’s examine how interchange works and the processing fees you can expect when accepting customer debit or credit payments. We’ll also look at the various pricing models that determine interchange fees, and how you can reduce interchange fees for your business.

How interchange works

Let’s take a look at what happens when a customer pays by debit or credit card during an in-store purchase:

• The acquirer sends the transaction information to the customer’s card network.

• The card network routes the transaction information to the cardholder's issuing bank.

• The cardholder's issuing bank will perform a number of checks (mainly to confirm that the customer has sufficient funds) before telling the card network whether the transaction is approved or declined.

• The card network passes this information to the acquirer.

• The acquirer processes the transaction.

• The cardholder's issuing bank deposits funds into the issuing bank's account.

Card network transfers and card network routes are responsible for moving transaction information between the acquiring bank and the cardholder's issuing bank during the processing of card transactions.

Note: Acquirer refers to the acquiring bank that processes card payments for the merchant. It’s connected to a card-issuing bank by a card network.

The acquirer incurs an interchange fee during this process. Each time a transaction is processed, the acquirer pays a fee to both the card issuer and the card network. The merchant will then have to pay this interchange fee to the acquirer, plus a markup to cover the handling cost.

The bulk of this payment processing fee is allocated to the card issuer to cover credit and fraud risks. A portion of the fees also goes to the card network. Interchange fees are generally charged as a percentage of the transaction value plus a fixed fee.

How much are interchange fees?

Interchange rates vary based on several factors, which we’ll address in the next section. Generally, you can expect to pay an average rate of 1.3–3.5% of the transaction value, plus a small fixed fee (usually $0.20 per transaction). These card processing fees include credit card interchange fees, which merchants pay when accepting card payments. The total card processing fees may also include other credit card fees and sometimes a flat fee component, depending on the payment processor's pricing model.

For example, a customer makes a $150 credit card purchase for a pair of wireless earbuds at a local electronics store. The merchant’s acquiring bank sends the transaction details to the card issuer, which approves or rejects the transaction. After the transaction is approved and processed, the merchant incurs a processing fee for this transaction, which includes the interchange fee. Merchants pay credit card interchange fees as part of the overall card processing fees for each transaction. If the interchange rate is 1.5% of the transaction amount, the merchant would pay $2.25. The average transaction size and average transaction sizes can influence the total interchange fees merchants pay, as larger transactions typically result in higher fees.

From that fee, $0.30 might go to the acquiring bank, $0.20 to the credit card network, and $1.75 to the card issuer. After these deductions, the merchant keeps $147.75 from the $150 sale. The customer would typically not notice these charges, as they would be included in the displayed price.

How are interchange fees determined?

Interchange fees are calculated based on several factors, including the card brand, transaction method, merchant category code, transaction volume, and the associated risk. Each card brand sets its own card interchange fee structure, and these fees are periodically updated to reflect changes in the market and regulatory environment.

Card present versus card-not-present transactions

Card present (CP) refers to a transaction in which the cardholder physically presents their payment card to the merchant. In contrast, card-not-present (CNP) refers to a transaction in which the cardholder doesn’t physically present their card. These transactions typically occur online or through alternative channels, such as over-the-phone payments, email, or fax.

CP transactions usually have lower interchange fees than CNP transactions. That’s because CNP transactions, including over-the-phone payments, generally carry a higher fraud risk, so card issuers may charge higher interchange fees to compensate for the increased risk involved.

Merchant Category Code (MCC)

Every merchant is assigned a four-digit Merchant Category Code (MCC) identifying their business type. A merchant’s MCC can affect the interchange fees they pay. For example, card networks typically charge lower interchange fees to charities compared to airlines, which face higher interchange fees because they are deemed a high-risk industry.

Card scheme

Interchange rates differ across card networks. The fee for a transaction made with a Visa card won’t be the same as one made with an American Express card. Each card brand determines its own card interchange fee structure, which can vary by region and card type. Visa and Mastercard are the two largest card networks that collect the majority of the world’s interchange fees. Card networks like American Express, Discover, JCB, and UnionPay also collect these fees.

Card type: credit versus debit

Credit card transactions typically incur higher fees than debit card transactions because credit card issuers use interchange fees to offset the risk associated with offering credit. Debit card payments carry less risk because they draw funds directly from the customer’s bank account. Debit card interchange and debit card interchange fees are regulated in some regions and may be capped by authorities to protect consumers and manage costs.

Credit card companies that offer customers rewards, such as air miles and cashback, may use interchange fees to offset these costs. While reward card payments may come with higher interchange fees than standard card payments, some merchants find paying these fees worthwhile as customers tend to spend more when using reward cards.

Place of card issuance

If a customer’s card were issued in a different country from the merchant’s bank, the interchange fees would be higher to offset the added complexities of cross-border transactions.

Security

Merchants that implement security measures (e.g., network tokenization and card security codes) to reduce fraud risk are often rewarded with lower interchange fees. Interchange fees also help fund fraud prevention measures and the network infrastructure required to maintain secure and reliable payment systems.

Consumer cards vs. commercial cards

Commercial cards (cards issued to businesses) usually have higher interchange fees than cards issued to individuals.

Transaction location

Some regions have introduced legislation to cap interchange fees. For example, in the European Union, consumer card interchange fees are capped at 0.3% of the transaction amount for consumer credit cards and 0.2% for consumer debit cards. Interregional card transactions have been capped at 1.15% for debit cards and 1.5% for credit cards. There’s no cap on commercial cards.

In Australia, interchange fees are capped at 0.8% for credit cards and 0.2% for debit cards.

In the US, interchange rates on credit cards aren’t capped, and fees average around 2% of the transaction value. However, following the Durbin Amendment in 2010, which is part of the Consumer Protection Act, debit card and prepaid card fees were capped at $0.22 plus five basis points multiplied by the transaction value. The Federal Reserve is responsible for regulating and updating these debit card interchange fee caps. Covered issuers – generally large banks – are subject to these caps, while exempt transactions, such as those involving certain prepaid or government-issued cards, are not.

Transaction volume can also impact the overall interchange fees a business pays, as higher transaction volume may lead to greater total costs. Some merchants set a minimum transaction amount for card payments to help manage interchange fees and control costs effectively.

In addition to interchange fees, merchants may also incur other fees associated with accepting payment cards, all of which contribute to the total cost structure of card payment acceptance.

Interchange pricing models

Payment processors use different models to calculate interchange rates. Businesses should understand these models, as they directly impact the cost of accepting credit or debit card payments.

Interchange plus pricing (also known as interchange++)

This pricing model is deemed highly transparent: Businesses know exactly how much they’re charged because they can see a breakdown of the fees from the card issuer, card network, and acquirer for each transaction. Interchange fees charged for each transaction will vary based on the factors we discussed above.

Tiered pricing

This model categorizes transactions into tiers based on risk and reward factors. Different card types are assigned varying interchange rates and fees within these tiers, making it difficult for businesses to predict costs due to fluctuating rates.

Flat-rate pricing (also known as blended pricing)

A fixed rate is charged per transaction, regardless of the card type or transaction method. This fee typically includes a percentage of the transaction value plus a fixed cost. This model simplifies budgeting for businesses as they can predict how much to spend on interchange fees monthly.

While fixed fees mean potential savings on transactions where card network and issuer rates are higher, there could be higher costs for transactions with lower rates. This model aims to provide a fair average rate per transaction, balancing out the overall costs.

Subscription

Under this model, businesses pay a monthly subscription fee in return for lower transaction costs. While the fees charged by the card issuer, card network, and acquirer are similar to the interchange plus model, the markup paid to the acquirer is a flat fee per transaction.

Card acceptance services often bundle interchange fees, flat fees, and other charges into their pricing models to streamline payment processing for merchants.

How interchange fees affect businesses

Interchange fees can significantly impact various aspects of your business, particularly when you accept card payments and process a high volume of card transactions. These fees can influence your decision to accept card payments and have a direct impact on overall profitability. These areas include:

• Operating costs: For businesses with many transactions or low margins, interchange fees can ‌make up a large part of operating costs and directly affect profitability.

• Pricing strategy: Businesses may need to modify their pricing to manage the costs associated with interchange fees. This could involve increasing product or service prices or implementing minimum charges for card payments, which could influence customer satisfaction.

• Cash flow: Interchange fees are typically deducted from transactions before the funds are deposited into your business’ bank account. This can affect cash flow management and make financial forecasting more challenging.

• Business model: Businesses may encourage customers to use cash transactions or debit cards, which generally incur lower fees than credit cards, to reduce overall costs.

• Payment processor: Businesses may choose payment processors based on interchange fee pricing models. The availability of payment methods can significantly influence a customer’s decision to make a purchase.

When you accept card payments, you must pay interchange fees and merchant service fees as part of the transaction process. Merchant service fees are distinct from interchange fees and cover the costs of processing payments, as well as network maintenance and services provided by payment processors or acquiring banks.

Besides interchange fees, businesses that operate internationally should be mindful of additional foreign exchange charges for cross-border transactions. Some payment processors charge upwards of 2% per transaction for currency conversion.

How businesses can reduce interchange fees

Here are some tips on how to reduce interchange fees. Managing interchange fees and other payment costs effectively is crucial for optimizing your operating costs and improving profitability:

• Choose the right payment processor: Different payment processors have different pricing models, and choosing one that fits your business can help you save money. It’s beneficial for small and medium-sized businesses to compare processors and find a cost-effective option.

• Optimise card processing: Card networks may offer lower interchange rates to businesses that follow best practices in card processing. This includes settling transactions promptly, using secure processing technologies like tokenization, and providing detailed transaction data.

• Encourage lower-cost payments: Small businesses can consider encouraging customers to use debit cards over credit cards or make cash payments.

• Consider surcharges: Adding a surcharge to credit card transactions can help offset interchange fees. But, consider this approach carefully, as it might not be favorable to your customers.

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