Credit card processing has one of the most confusing fee structures that exists amongst all industries. Fees are an absolutely necessary expense if you want to process credit card transactions, but the complicated jargon and calculations can make it difficult to know what you’re spending and why.
Merchant processors can charge a wide variety of rates under different pricing models, so an apples-to-apples comparison isn’t always possible, especially if you’re just viewing something on your own.
This is why we offer a free credit card processing fee review. First Payment Services always looks at your most recent merchant statements to give you a true apples-to-apples comparison. If you’re interested, contact us here after you’ve read through the article.
So how do you even begin to understand your credit card processing fees? This article will break down what fees you can expect, why the fees exist, and how you can save hundreds to thousands of dollars (we see it all the time).
Table of Contents
What Is Credit Card Processing?
When merchants sell their goods or services, they accept payment from their customers. Sometimes, that payment is in the form of cash. More often than not, that payment is in the form of a debit or credit card.
Merchants need a way to process those credit card transactions and get the money that they are due. This is where credit card processing comes in.
There’s a lot going behind the scenes when a credit or debit card is swiped. There are many parties involved in the processing: the merchant, the processor, the issuing bank, and the card network. Card processing usually follows these steps:
- The customer pays for the goods or services by using their card.
- The merchant records the information and sends it over the payment processor.
- The processor liaises with the customer’s bank via card organization (Visa, MasterCard, etc.) to get authorization for the transaction.
- The bank then either approves or denies the purchase, depending on your available funds.
- If the transaction is approved, the payment processor sends that information back to the merchant, who finalizes your purchase.
Each party charges a fee to process your credit card transactions. This can range anywhere from 1.5% to 5% of your total monthly sales volume. While the difference doesn’t sound like much, that amount can add up. This is especially true for businesses with high ticket items or a large volume of sales. You could be paying hundreds or even thousands of dollars a month in processing fees, so it’s important to know exactly what these fees are.
If you’re more interested in a complete overview of credit card processing, we’ve also written an article titled: How Credit Card Processing Works, which does a fantastic job of explaining every detail behind the mysterious process.
What Are The Fees Involved?
There are tons of different fees involved when any given credit card transaction is processed. These fees are split between the issuing bank, credit card association, and the payment processor.
As the merchant, you are paying these fees for the convenience of offering credit card payment options to your customers; however, the fees aren’t straightforward or simple as one might hope.
Interchange Fees
Interchange fees make up the bulk of the cost of credit card processing. These are fixed costs determined by the issuing banks and the card association. Interchange fees take into consideration the card type, transaction risk, merchant category, and a dozen other variables to come up with a processing fee. This results in over 300 different interchange fees.
What many people don’t know is that interchange fees are the same for every processor and are non-negotiable. This means that no matter what merchant acquirer you work with, the interchange fees will remain the same (although, depending on the pricing model, you may or may not see what the interchange fees are).
Because interchange fees go directly to the issuing bank, no processor will ever quote you anything lower than the interchange rates. Interchange rates are a percentage of the transaction plus a small per transaction fee, such as 0.8% + $0.15.
Factors That Affect Interchange Rates
Not all interchange rates are equal. Banks consider a variety of factors to come up with hundreds of different interchange fees. One major factor is the card type used. PIN debit cards have the lowest risk, so they are often charged the lowest interchange rates. On the other hand, credit cards, business cards, and rewards cards have a higher risk of fraud and the highest interchange rates.
Another factor that gets computed into the rates is the processing method. In-person or card-present transactions (via swipe, dip, or tap in store) have lower rates compared to card-not-present transactions processed online or over the phone.
Your type of business can also affect your interchange rates. Each merchant is given a 4-digit merchant category code. Depending on how risky your industry is, you could be charged different rates. Highisk businesses like financial services will have completely different interchange rates from lowisk businesses like retail merchants.
You could also potentially get a lower interchange rate by leveraging your ticket size or sales volume. Businesses with low average ticket size or a large amount of monthly sales may qualify for lower interchange rates, depending on the processor.
Assessment Fees
Assessment fees are charged by the card association (Visa, MasterCard, American Express, Discover) and are often added to the interchange rates. This is another non-negotiable fee that is the same for all card processors. Assessment fees are calculated based on your monthly sales volume, what kind of cards were used, whether or not foreign transactions were involved, and other factors.
Assessment fees can either be a percentage of the transaction or a small flat fee per transaction (e.g. 0.8% OR $0.15).
Markup or Interchange Plus
If interchange and assessment fees are the same across all payment processors, why do processors have different rates? That difference can be attributed to the markup. The markup fees are where the processors make their money.
Markup fees are generally negotiable. They usually come in the form of a percentage plus a dollar amount per transaction. Markups may be a small addition on top of the base cost (interchange + assessment), but those fees will take a not-insignificant chunk of your sales. Because this is the only part of the fee structure that is dictated by the processor, it’s also the one where you can potentially get the best deal.
Interchange Fees can get as high as (Interchange + 3.00% and $.75 per item. This is the worst I’ve seen someone charged from a shady processor. We’ve spoken about our rates in previous articles, but in general, people can expect anything from “Interchange + .05% and $.10 to Interchange + .10% and $.20 (it depends on merchant size, equipment, etc.). Processing isn’t always rigid and the benefit of sending a merchant statement to First Payment Services for analysis is that you’ll get a far more flexible and competive deal on rates.
Additional Fees
You can also have additional fees in the form of monthly or annual charges like service fees, excessive authorization fees, cancellation fees, setup fees, PCI compliance fees, POS hardware rental fees, and more.
Credit Card Processing Models
Before diving into the world of credit card processing fees, you need to understand the concept of different pricing models.
If you’ve shopped around for different merchant processors before, you’ll notice that they charge wildly different fees. Some are a percentage plus a transaction fee (e.g. 1.2% + $0.05), some are just a flat percentage (e.g. 5%) while others have anywhere from three to over hundreds of different rates!
If merchant processors are all basically doing the same work, why is there no consensus on what they charge? This is because processors follow different pricing models. We’ll go into the three most common models in detail.
Interchange Plus Rate
The interchange plus pricing model is the most confusing but also the most transparent. Basically, the processor will charge you the interchange ratesplus their markup. The costs are kept separate which means that you can easily figure out what the processor’s markup is and, therefore, how much you can negotiate from there.
The benefit of an interchange plus pricing model is that you get charged only a small markup per transaction. Plus, each transaction has a specific rate depending on many factors (e.g. card type, processing method, etc.). With interchange plus, you only pay that particular interchange rate plus a small fee for the processor. If interchange fees increase or decrease, you’ll be able to clearly see this reflected on your merchant statement. It’s also the least expensive of the pricing models.
The main downside of this pricing model is that it is a little bit more complicated to understand. However, this is nothing that some time and patience can’t fix. For this reason, interchange plus is the recommended pricing model for most businesses.
Tiered/Bundled Rate
Tiered pricing, also known as bundled pricing or bucket pricing, tries to simplify credit card processing for the merchant. Instead of charging a distinct fee for each unique kind of transaction, tiered pricing lumps hundreds of transaction types into a few categories. A bundled pricing model can have any number of tiers, although a three-tiered model is the most common.
Using a “qualification matrix”, the processor routes different interchange fees into one of the three tiers: qualified, mid-qualified, and non-qualified. Qualified rates are usually the lowest, while non-qualified rates have higher fees.
In theory, it’s much easier to understand because you only have to look at a few rates versus hundreds of different ones, but this pricing model is prone to a lot of manipulation by the payment processors.
Tiered pricing isn’t transparent about what rates fall under which categories, and processors can change their qualification matrix at any time. So while you are roped in with the promise of low (qualified) rates, the processor can just funnel more and more of your transactions into the mid- or non-qualified tiers without giving you a breakdown. You effectively end up paying significantly more per transaction than what you initially signed up for.
There’s also no way to directly compare tiered pricing between processors. There isn’t a standard criteria for the tier qualification. This means that one processor can charge lower rates on paper but raise your costs by routing more transactions to higherated tiers.
Flat Rate
Another simplified pricing model is flat rate pricing. Unlike tiered or interchange plus pricing which ascribes different rates for different kinds of transactions, flat rate systems charge a single rate for ALL transactions. The upside is that you don’t have to deal with multiple rates and you can easily compute your monthly fees. However, flat rates end up being the most expensive pricing model overall.
Processors like Square and PayPal offer easy flat rate pricing for businesses who don’t want to bother with the intricacies of credit card processing or monthly fees. The convenience can come at a cost, so this pricing model is only really recommended for businesses with a very low sales volume.
How To Save On Credit Card Processing Fees
While non-negotiable base costs make up the majority of your credit card processing fees, there is a lot of room to save on the markups and other additional charges. Here are our top tips on minimizing your expenses and maximizing your sales.
Do Your Research
The biggest obstacle to big savings is not understanding how credit card processing works and what fees you need to pay. Know the ins-and-outs of credit card processing, and no processor can swindle you again. Learn the terminology, the difference between pricing models, and how to read your merchant statement. The more you know, the better equipped you will be when negotiating or shopping for a new acquirer.
Stop Looking At The Transaction Rate
When most merchants look for a processor, they make the mistake of comparing based on rates. The best processor isn’t always necessarily the one that offers you the lowest possible rates. Instead, look for the lowest possible markup. Rates can hide or distort the actual cost of processing, especially with less transparent pricing models like tiered or flat rate pricing. You want to look for a processor that offers you rates as close to the base cost as possible.
To find the markup, separate the interchange rates from the added fees. This might not be doable with a tiered pricing model. The more you can identify each cost component, the more you can identify saving potential.
Compute Your Effective Rate
The individual fees or percentages don’t matter in the long run, but the overall effective rate does. Additional fees are, on average, 23-60% higher than your quoted rate. Your effective rate combines your transaction fees and additional charges to give you a more accurate picture of how much you’re actually paying compared to your sales.
Computing your effective rate is easy. Just use this formula:
(Total Fees Paid / Total Sales Volume) X 100 = Effective Rate
Ex. $24 fees / $1,000 in sales = 2.4% effective rate
Once you have your effective rate, you can get sample quotes from competing processors and compare your net profit much easier.
I can’t stress this enough though. Processors can claim a price or a rate, but they can’t hide if you use effective rates. All the buried fees come to light ultimately in the percentage. For another processor to truly know how much they could save you, they would need to see a merchant statement (like I keep mentioning).
Shop Around
Credit card processing fees are one of the biggest business expenses, so it’s important to do your due diligence. Never settle for the first merchant processor you talk to. Ask for quotes from different processors and compare them. Take your time and find the best deal possible for your business.
Avoid Flat Rate Processors (If Price Matters)
Sure, they are simpler to understand. A flat rate fee for all of your transactions is easier off the bat but will cost your business valuable money in the long run. However, because of the lack of monthly fees and other costs, flat rate processors may be a viable option—but only for low volume businesses. Interchange plus is a cheaper and more transparent option that is suitable for ALL business.
Think about it this way – If a company doesn’t know what kinds of cards go through your business, it needs to make sure to pad their rate offering to make sure that they won’t lose many by offering a flat universal rate. But what ends up happening is that the financial risk of certain types of cards gets universally distributed to their merchants in order to distribute financial risk.
In short, it’s better to get a processing fee type that is customized and transparent.
Negotiate Before Switching
If you already have a merchant processor but aren’t happy with your current rates, don’t immediately switch to another processor. Since all vendors buy the same exact rates from card issuers and associations, it’s not a question ofcan they lower your rates, but will they.
If you have a high sales volume, leverage that during the negotiations. The more business you provide to your processor, the more willing they will be to lower your fees. You can also employ the services of a credit card processing expert to help you talk to your provider and get you better rates.
It’s possible to use your new knowledge of credit card processing to negotiate your rates down with your existing processor. This helps you avoid costly cancellation fees or the downtime associated with switching acquirers.
Minimize Risky Transactions
You can’t change the interchange rates associated with a transaction, but you can optimize your operations to get the lowest interchange rates and fees possible. Some transactions are considered riskier for your processor to take on and are therefore more expensive to process. Limit these risky transactions by implementing a few security measures.
You can lower your credit card processing fees by entering in extra security information, such as the billing ZIP or security codes, during the transaction. Use an AVS (address verification service) for online purchases; card associations incentivize this extra step by offering lower interchange rates for AVS-verified transactions. Make sure your business is PCI-compliant to avoid non-compliance fees. Minimize your chargeback costs by using a credit card authorization form.
Lastly, swipe more credit cards. Do card-present transactions as much as you can. The more credit cards you process, the less risk you pose as a merchant. You will be able to use that to negotiate your rates down in the future.
Set Up And Use Your Account Properly
You risk incurring extra fees if you don’t set up your merchant account properly. Select the correct business category, transaction types, and transaction frequency. This way, you will get the most accurate credit card processing rates.
Batch process your transactions every 24 hours, instead of doing it once or twice a week. It’s a small added inconvenience, but it’s also one of the easiest and most cost-effective ways to help you avoid unnecessary fees.
Require A Minimum Amount For Card Purchases (or Charge Extra)
The fees associated with low ticket sizes can actually cost more than you earn. Solve this problem by requiring that customers meet a certain amount before they can use a credit card. This offsets transaction costs and makes the processing fee worthwhile.
Merchants can also pass an extra fee up to 3% onto the merchant transaction (as of a very recent mandate from Visa). This can’t be done in all states, but if you’d like to read more on this specific aspect of the processing world, card fellow has a good article on the subject.
Conclusion
Each credit card processor charges a wide variety of fees; some are non-negotiable, but the rest offer a great opportunity for increased savings. Take the time to learn about credit card processing, and you could significantly reduce your business’ expenses.
