EXPLAINING CREDIT CARD PROCESSING FEES
So you’ve started a business and you want to accept credit card payments, and now it’s a matter of choosing which processor to work with. The Big Tech companies all advertise similar merchant processing rates (somewhere around 2.9%), so you figure you’ll have to calculate about 3% of your revenue going out the door – and that’s just the cost of doing business, right?
Well, it doesn’t have to be this way. For your business maybe it shouldn’t.
Understanding credit card processing fees is the first step towards potentially lowering the rate you pay. Have you ever asked, Why are card processing companies taking 2.9% just to handle credit card payments for my business?
We’re going to cover a lot of ground, but we’re going to take some breaks along the way to break up the monotony. Enjoy this video before we review some basics of how credit card processing works:
How Credit Card Processing Works
When a customer uses her credit card to buy your product, there are three entities at work behind the scenes to make sure money goes from your customer’s bank account to your bank account:
The Issuing Bank. This is the financial institution that issues the credit card to your customer. You’ve probably heard of Chase, Bank of America, or Citibank.
Credit Card Networks. You’ve also heard of these guys – Visa and Mastercard probably come to mind first. They distribute the credit cards to consumers and operate the network infrastructure that connects the financial institutions and moves the money from one account to another.
The Processor. This is the “middle man” that communicates with the issuing bank via the credit card networks to approve the credit card transaction. These are sometimes called Independent Sales Organizations (ISOs) or Acquirers. They serve merchants directly by taking the transaction information from your business’s website or point of sale machine and sending it through the credit card networks.
Every time a card is swiped, tapped, dipped or keyed, your processor sends the transaction info via the credit card networks to the customer’s bank, and then makes sure that the payment eventually lands in your bank account.
What’s In a Credit Card Fee?
Credit card fees have two components, the percentage of each transaction plus a transaction fee. Many processors offer to assess merchants one simple fee structure for all card transactions which includes a set percentage and per transaction fee (this is called flat rate pricing, like in our example above of 2.9% plus 30 cents). However, the banks and credit card companies charge processors variable rates per transaction that is based on specific transaction factors. This rate is called the interchange rate.
The interchange rate is a percentage fee that is set by both the issuing banks and the credit card companies, and these rates are the same for all processors. Every card type has a specific interchange rate, and the interchange rate also varies based on the method the card data was entered or captured.
For example, a Visa debit card has a lower interchange rate than a Visa credit card.
A Visa credit card that is swiped has a lower interchange rate than a Visa credit card that is manually keyed (either online or in person).
The per transaction fee also varies by card type and entry method.
Flat Rate Pricing
Flat rate pricing is exactly what it sounds like. When you use flat rate pricing, all of your transactions are assessed one flat rate. This rate includes both the interchange rate plus the processor’s markup. So, if your rate is 2.9% plus 30 cents, then for a $100 sale your fee would be $3.20 ($2.90 plus 30 cents). The biggest advantage of this pricing model is that it is consistently simple and there are no surprises.
Interchange Plus Pricing
With interchange plus pricing, you are agreeing to pay the interchange rate plus a fixed margin or markup set by your processor. The biggest advantage of this pricing model is that merchants typically pay less in overall credit card fees, and the card breakdown is visible on each monthly processing statement.
It’s important to note that both pricing models have pros and cons.
Pros: Flat Rate Pricing
Simplicity. With flat rate processing, you pay the same amount for every transaction, which is refreshingly simple.
Predictability. With a single rate you can adjust your fixed cost per transaction to better set your own prices. You’ll have no surprises at the end of each month, and you can more easily set profitability forecasts based on sales volume.
Flexibility. Certain cards (ever heard of American Express?) charge higher interchange rates than others. Many merchants have been unwilling to accept these elite brands from their customers due to prohibitive processing costs, which can often exceed the locked in flat rates offered by processors.
Cons: Flat Rate Pricing
Unnecessary Expense. If the majority of your clients are using debit cards with low interchange rates, you won’t see any benefit. Your processor, on the other hand, will be giddy.
Lack of Transparency. Usually, flat rate card statements do not offer merchants a breakdown of the card types used in transactions. This can make it difficult to shop for a lower rate elsewhere.
Pros: Interchange Plus Pricing
Savings. If your customers are using cards with lower interchange rates, the price you pay will also be lower. In fact, your rate may be lower even if your customers are using credit cards with higher interchange rates depending on the margin set by your processing agreement. While the typical flat rate is around 2.9%, the effective monthly rate for interchange plus pricing can be well below 2.5%.
Keep in mind, debit card interchange rates are significantly less than 2%.
Transparency. With interchange plus you’ll always see the fees you’re paying for each transaction. You will also know the amount your processor is charging you above the interchange rate, so you can easily compare processors.
Cons: Interchange Plus Pricing
Complexity. Because each transaction has a different price associated with it, and you can’t predict the exact number and type of transactions you’ll get each month, your costs become harder to predict.
Higher Rates. If you experience an influx of transactions from those elite card brands, your overall rate may exceed the flat rate offered by your processor.
Hidden Fees. Processing companies may bury unnecessary fees in a complex monthly statement hoping you won’t notice.
Which is right for your business?
Each business owner has to weigh the pros and cons of what works best for their business model. Do you sell a high volume of lower-ticket products and services? Are most of your sales to other businesses who frequently use elite card brands? There’s no one-size-fits all solution, so it’s important to find a processor who will have these conversations and be transparent about what they offer.
Article By: Erik Smith, Dime Business Development Manager