In processing credit card payments, understanding the reason behind the interchange fee becomes important. The interchange fee, also called the discount rate or swipe fee, is the sum paid by merchants to the credit card processor as a fee for accepting credit cards.
The amount of the rate will vary depending on the type of transaction, but averages about 2 percent of the purchase amount. The interchange fee is typically higher for online purchases than for in-person purchases. This is because, in the latter, the card is physically present and available for an inspection.
Concerning processing credit card payments, interchange fees account for the majority of credit card processing expenses. Having an understanding of the interchange fee system is important for any business owner.
At the time of transaction, an interchange fee is issued to the customer’s, known as the “issuing bank” or the bank that issued the card used for purchase. The fee is paid by the merchant’s bank, known as the “acquiring bank.”
This fee makes accepting credit cards desirable and commercially viable for merchants who normally might not be able to enjoy the same security, expediency, and guarantee of payment that usually comes with credit card purchases.
Further, interchange fees are not static, immutable fees imposed on electronic payments systems. While MasterCard, for example, sets “default” rates of interchange, the merchant in any transaction has the right to negotiate card acceptance costs with his or her acquiring bank. The acquiring and issuing banks are permitted to negotiate between themselves. This allows electronic payment system users and their banks to easily and fairly conduct business using credit card transactions.
Historically, interchange fees have been imposed upon merchants to reimburse issuing banks for lost interest resulting from a cardholder’s grace period for repaying their debt.
When a credit card transaction takes place, the issuing bank (cardholder’s bank) pays the acquiring bank (merchant bank) for their cardholder’s purchase less the interchange fee for the transaction.
The acquiring bank then pays their merchant from the remaining balance minus a markup for processing credit card payments. Merchants ultimately receive the gross amount of the sale minus a series of base costs and markups that include interchange, dues, assessments and the provider’s markup.
These fees are set by the credit card networks, and are the largest component of the various fees that most merchants pay for the privilege of accepting credit cards. The interchange represents 70% to 90% of these fees, although larger merchants typically pay less.
In recent years, interchange fees have become a controversial issue. Many large merchants that are involved in processing credit card payments, such as Wal-Mart, have the ability to negotiate fee prices. While some merchants prefer cash or PIN-based debit cards, most believe they cannot realistically refuse to accept the major card network-branded cards. This holds true even when their interchange fees exceed their profit margins.