What are Interchange Fees?

Interchange fees are transaction fees paid by acquiring banks to issuing banks for processing credit and debit card payments. These fees are established by card networks like Visa and Mastercard, and typically combine a percentage of the transaction amount with a fixed charge. While merchants don’t directly pay interchange fees, they ultimately bear the cost through their payment processing fees, which incorporate interchange along with other charges.

How do Interchange Fees Work?

When a cardholder initiates a transaction, multiple financial institutions process the payment and take a cut. First, the merchant’s acquiring bank accepts the payment and routes it through the card scheme, who takes a percentage as a network fee. The card scheme then sends the transaction details to the cardholder’s issuing bank, who approves or declines the payment. If approved, the issuing bank charges the merchant’s bank an interchange fee – typically a percentage of the sale plus a fixed amount.

The acquirer combines these various fees – the card scheme fee, interchange fee, plus their own processing charges – and passes them onto the merchant as payment processing fees. These combined fees vary based on factors like card type, transaction method, and the merchant’s industry classification. In a nutshell, interchange fees serve three main purposes:

1.Risk compensation: They compensate the issuing bank for taking on the credit risk when they guarantee payment to merchants, even if cardholders default.
2.Infrastructure support: The fees help cover the costs of operating and maintaining the card payment system infrastructure, including fraud prevention, dispute resolution, and network technology.

Card program funding: They encourage credit card use by helping to fund cardholder benefits like rewards programs, fraud protection, and interest-free periods.

What Determines Interchange Fee Rates?

There are a wide variety of factors that influence the interchange fees a merchant is charged, including transaction type, card scheme rules, merchant category code, and geographic location. Here’s a breakdown of how these factors may affect your fees:

Transaction Type

Credit cards typically carry much higher interchange fees than debit cards, with premium rewards cards bearing the largest costs. While debit interchange fees are capped at 21 cents plus 0.05% of the transaction value (plus a 1-cent fraud prevention adjustment), credit card fees can range from 1.15% + $0.25 for fuel purchases to 2.55% + $0.10 for airline tickets.

Card Scheme Rules

Different card schemes also charge different amounts for interchange fees incurred by credit card transactions. Of the major networks, Visa’s and Mastercard’s rates are similar, at between 1.4–2.5%, and 1.5–2.6% respectively. Discover charges slightly more, at between 1.55–2.5%, while American Express charges significantly higher fees, from 2.3–3.5%. Discover and Amex are able to charge slightly higher fees because, as both issuers and networks, they are not bound by the same restrictions as conventional card schemes.

Merchants Category Codes

Merchant category codes (MCCs) also play a key role in determining interchange rates. These four-digit codes, assigned by card networks, classify businesses based on their primary activities. Different MCCs carry different interchange rates, reflecting the networks’ assessment of transaction risk and value. For example, grocery stores typically enjoy lower rates than online retailers, reflecting the different risk profiles of card-present versus card-not-present transactions.

Transaction Amount

The influence of transaction amount on interchange fees follows a generally inverse relationship – as transaction values increase, percentage rates often decrease. This is particularly true for commercial cards and B2B purchases, where high-value transactions may qualify for significantly lower percentage rates. However, these reduced rates are typically offset by higher fixed fees per transaction.

Cross Border Transactions

Finally, geographic considerations also affect interchange fees significantly, particularly for cross-border transactions. International purchases often incur additional fees beyond domestic rates, while different regions may have varying regulatory caps on interchange. For instance, the European Union caps interchange fees at 0.2% for debit cards and 0.3% for credit cards, while rates in the United States are substantially higher.

How Do Interchange Fees Impact Merchants?

While individual transaction fees may seem modest, they can amount to significant costs – sometimes consuming 2-3% of total revenue for high-risk merchants. The impact becomes particularly acute when dealing with high levels of premium credit card transactions, which carry higher interchange rates but are increasingly popular with customers due to their generous rewards programs.

Many merchants, especially those new to card acceptance or expanding into new markets, underestimate how these fees compound across thousands of transactions and multiple card types. When combined with other processing fees and potential chargeback losses, interchange costs can seriously erode profit margins that appeared healthy on paper, forcing businesses to either raise prices or absorb unexpected costs.

What Can Merchants Do About Interchange Fees?

Fortunately for merchants, there are often measures available that can curb the impact of interchange fees. However, it should be noted that not all of the following strategies will work for all merchants, and often your interchange fees are very difficult to change.

• Negotiate Processing Rates: Merchants with higher transaction volumes have better leverage to negotiate interchange rates with payment processors. Compare offers from multiple providers and use your volume as bargaining power.
• Optimize Transaction Processing: Submit transactions within 24 hours, maintain updated payment security measures, and ensure complete data transmission. Proper categorization and timely settlement often qualify for better rates.
• Encourage Lower-Cost Payment Methods: Promote debit card usage through incentives or discounts where allowed, and consider offering ACH payments for recurring transactions. However, it is important that you avoid alienating customers who would prefer to pay with credit cards.
• Monitor and Review Regularly: Check your processing statements biannually to catch rate changes. Networks update interchange fees twice yearly – April and October. Use this data to evaluate processor relationships and identify potential savings.
• Provide Enhanced Data: Submit detailed transaction information to issuers, especially for business and high-ticket purchases. The provision of detailed (level 2/3) data can qualify for lower interchange rates on commercial cards.

The Compounded Impact for High-Risk Merchants

For merchants classified as high-risk via their MCCs, interchange fees create an especially challenging financial burden. This is because the significant loss of revenue incurred by elevated interchange fees is typically matched by higher chargeback frequencies and dispute fees. This combination can significantly impact profitability – interchange rates can slice off up to 3% of earnings, while chargebacks can incur a further loss of up to 25% net income, even before the accompanying fees, fines, and penalties are meted out.

Balance the Cost of Interchange Fees with Chargebacks Won

While merchants might have limited control over their interchange rates, they can take active steps to defend themselves against chargebacks, potentially recouping the cost of interchange fees many times over. This proactive approach may prove essential for maintaining profitability, particularly for high-risk merchants already operating on tight margins due to premium interchange rates.

Justt’s AI-powered solution helps merchants fight illegitimate chargebacks hands-free, maintaining industry-highest win rates at any scale. The system conducts machine learning-driven A/B testing so that it’s always improving, as much as doubling win rates within weeks. For businesses struggling with the impact of high interchange fees and frequent chargebacks, Justt’s solution offers a simple way to protect revenue without increasing operational complexity, and turn your high-risk status into a high-reward scenario.