Breaking down credit card processing fees

Monday, November 03, 2014

Let’s face it – starting a small business is tough. You, as a small business owner, have so much to keep an eye on. Often, you’re the head marketer, the bookkeeper, and the salesperson. So once you make the decision to accept credit cards, you want the transaction process to be smooth. But when it comes to credit card processing, there’s a lot to keep track of. So in this article, we’ll help to simplify the various credit card processing fees that your business might face.

First, let’s talk about credit card processing in general. Then, we’ll move to the most popular credit card processing structures. Finally, we’ll discuss factors that can help your company lower its credit card processing fees.

What’s in a credit card processing fee?

When you decide to accept credit cards at your business, you’ll work with a merchant services provider who facilitates this process. The merchant services provider may also provide other services to your business, including POS software, payment gateways and customer data tracking. When a customer pays you with a credit card, this transaction moves through a whole network of entities, and ends with you getting money from the transaction. Credit card processing fees are the cost of getting the money that the customer paid into your merchant account.

Typically, when you accept credit cards, you’ll have to pay multiple fees with each transaction. However, it might be more apt to think of each processing fee as a “bundle of fees.” This bundle of fees can typically range from 1.5-3.5% of each transaction. As you'll see, average credit card processing fees can vary based on a number of factors. Let’s break down these factors to see what's usually included in the fee.

Payment processing fees

Usually, the payment service provider charges fees for using their services. These can vary in cost and how they’re billed, depending on the agreement. The payment processor might also charge fees for providing an online gateway for online transactions.

Interchange fees

When someone swipes a credit card at your business, the bank that issues the card gets paid a fee. This fee, called an interchange fee or discount rate, covers handling costs, fraud and bad debt costs, chargeback fees, and reissuing compromised cards. Since the institution is taking on the risk of the cardholder not paying the money back (as well as these costs), it makes sense that they’d need to charge a fee to protect themselves.

Interchange fees are constantly changing. A large number of variables affect interchange fees, including type of credit card, business size and industry, and transaction type. These standardized fees do not change based on who you use as your payment service provider.

Assessment fees

As a business, you'll pay assessment fees directly to the card networks like Visa, Discover or Mastercard. This is one way credit card networks make their money. Similar to interchange fees, assessment fees are a fixed cost and because they are set and standardized by the card networks, they cannot change based on your payment service provider.

Other fees

There are additional fees associated with payment processing that vary by provider. Some common miscellaneous service fees include:

Chargeback fees – the fees you have to pay to return the customer’s money to their account
Setup fees – one-time fees to get your account started with the payment service provider
PCI compliance fees – the cost of adhering to the standards set by the Payment Card Industry Data Security Standard
Monthly minimum fees – charges levied when your business fails to complete a minimum number of transactions
Statement fee – the cost of printing and mailing credit card statements
Non-sufficient funds fees – fees charged to you should you not have enough money in your bank account to cover the credit card processor’s charges.
Equipment costs – either as an initial cost or as a rental fee, depending on your business’s situation

Now that you understand the broad categories of transaction fees, let’s take a deeper look at interchange fees. These fees can vary depending on a variety of factors.

The factors affecting interchange rates

As discussed above, the issuing bank gets paid the interchange fees. Because the issuing bank is taking on risk by approving transactions, the interchange fees can vary depending on each transaction. Here are a few of the factors that can influence the interchange rate:

Debit vs. credit

When it comes to interchange fees, payment method matters. Debit card interchange fees are much less expensive than credit card interchange fees. The biggest reason for this is the amount of risk the issuing bank takes on. In a debit card transaction, if the cardholder has enough money in their account to cover the transaction, it’s approved. But, when it comes to credit cards, the issuing bank is covering the cost of the transaction for the consumer. Then, the consumer pays the issuing bank back at a later date. Most of the time, the credit card transaction gets approved if the cardholder isn’t attempting to outspend their credit card limit.

Card present vs card not present transactions

As you may know, there are two types of transactions – card present and card not present. The card is present in the first. In the second, the card owner shares the card by phone or online. The difference in method of payment does make a big difference in interchange rates. Card not present transactions are high-risk transactions, so the interchange fees on these types of transactions are higher than the fees if the card is present.

Transaction category

Interchange fees also vary based on the transaction category. Every major credit card company has business merchant category codes (MCC). Each of these business MCCs is a four-digit number that reflects the goods or services provided by the merchant. If your business is in a higher risk category – take pawn shops as an example – you could pay higher fees. It’s important to contact your payment processor to discuss in more detail how your type of business could affect your interchange fees. If your business is in a higher-rate category, there are certain payment processing contracts designed for similar businesses.

Rewards cards vs non-rewards cards

Another factor that affects the interchange rate for small businesses like yours is if the consumer’s credit card is a rewards card or not. Rewards cards are popular for consumers, offering them points they can redeem for airfare, hotel stays and cash back. While these cards reward the customer for spending money on them, the merchant is the one who feels these costs the most. That’s because rewards cards have higher interchange rates. However, rewards cards can promote higher spending at your business.

Credit card brand

The credit card brand also affects the interchange fee. That’s because each credit card company – Visa, Mastercard, Discover and American Express – charge slightly different fees. It’s important to note that Amex and Discover act as both credit card networks and credit card issuing banks. Therefore, their rates may be different as well.

Card owner

Another surprising factor to interchange fees is the cardholder. Again, issuing banks are setting rates based on inherent risk. In this case, government agencies or big corporations are less risky than everyday consumers. Therefore, when these types of cardholders use their cards at your business, you may pay less in interchange fees.

Keep in mind, these are just the most prominent factors for interchange fees. For a more detailed list of every interchange fee, you’ll need to reference each credit card company’s publications. Now that you know more about interchange fees and the factors that affect them, let’s move on to payment processing fee structure.

Payment processing fee structure

Tiered pricing

When your company uses a payment processor, you pay them for utilizing their services. Each payment processor is different, but there are a few general pricing structures that payment processors tend to have. In this section, we’ll expand on each of the three main types.

Each merchant services provider sets their own buckets of transactions, so it’s important to talk with your payment processor so that you know how they calculate each tier.

Flat-rate pricing

In this pricing model, the merchant services provider charges the merchant a fixed percentage, or flat fee, for each transaction. Transactions are usually split up into card present (in-store), card not present (ecommerce), and manually entered (mail and telephone orders) transactions. In each category, the transaction type determines the flat fee. The issuing bank and credit card issuer have no bearing on the fee. Put another way, the rate is based on the method used to charge the card.

Again, it’s important to talk with your payment processor to get a full grasp on the flat-rate pricing options available.

Interchange plus pricing

In this pricing model, the merchant services provider charges the merchant the interchange rate and then adds on their fees, typically a percentage of each transaction plus a fixed fee per transaction. For example, a small business would pay the payment processor the base interchange fee plus a set percentage of the transaction. Some payment processors also add a fixed fee to each transaction in this pricing model. As always, it’s best to contact your payment processor for their exact pricing.

In addition to these general pricing models, a credit card processing company may charge other fees related to your business. Some common fees include monthly fees or annual account fees, equipment rental fees and more. It’s important to discuss the sum of these fees with your payment processor directly.

Now that we’ve discussed the different types of payment processing fees, let’s discuss ways your small business can lower its payment processing fees.

Lowering credit card processing fees

As we’ve discussed, credit card processing fees are a bundle of fees. As part of the bundle, the card issuers set the interchange fees (which go to the banks issuing the cards) while the card networks set the assessment fees (the costs for using the cards). These are both fixed and non-negotiable. So in order to lower your credit card processing fees, you’ll have to work directly with your payment service provider, as their rates are the part of the equation that can change. There are several factors that go into a payment processor’s likelihood of lowering your fees. Here are a few of the factors:

High monthly processing volume

The more credit card transactions your business processes, the more valuable your business is to a payment processor. This is due to the payment processor taking a percentage of your sales as their markup. Therefore, with a higher transaction volume, you might be able to negotiate a lower rate.

High average ticket size

If your business has a high value average ticket, a payment processor may see you as a more valuable customer. This is because payment processors are getting a percentage of transactions, and the higher the transaction amount, the more they stand to make from you.

Reduced risk of fraud

If you’re in a fixed brick-and-mortar location, only accepting cards in-person, your transactional risk is lower. This is because you can verify the use of a physical card at a credit card terminal. These transactions pose a lower risk of fraudulent activity, because a customer swipes or dips a card at a card reader. The lower the risk of fraud at your business, the lower risk the payment processor has to incur. In order to limit your risk, the best way to accept credit card payments is card present transactions at a card reader using EMV technology, while limiting the number of keyed-in transactions you process.

Another important element in reducing fraud and chargebacks is utilizing the address verification system. It’s a tool used for online purchases in which the system compares the billing address to the address on file of the cardholder at the issuing bank. By matching these addresses up, you’ll be able to more accurately authenticate your customers. This verification helps to mitigate fraudulent transactions by authenticating or rejecting cards before their approval.

Good processing history

Like all businesses, a strong history of processed sales is an indicator of a reliable partner and could entitle you to a lower rate. This is because, like any business, payment processors want steady relationships. By proving that your business is a reliable partner with a good reputation of transactions and low incidences of fraudulent charges or chargebacks, a payment processor may be more willing to negotiate your rates.

Excellent business and personal credit

The better the business’ and your own personal credit history are, the more likely you are to be able to negotiate fees. This makes sense because you’ve proven that you are capable of being a responsible borrower.

Now that you’ve learned more about the credit card processing fees your business can incur, you’re well on your way to doing what’s best for your business. While there are many standardized fees in the industry, others are negotiable based on the factors we’ve discussed. The best solution is finding a payment processing partner who is able to accurately assess your small business’ needs and then put together a plan to fit those needs.

Ready to find a partner to handle your payment processing needs?

Heartland is the point of sale, payments and payroll solution of choice for entrepreneurs that need human-centered technology to sell more, keep customers coming back and spend less time in the back office. Nearly 1,000,000 businesses trust us to guide them through market changes and technology challenges, so they can stay competitive and focus on building remarkable businesses instead of managing the daily grind.