Interchange rates explained

Merchant services is confusing when it comes to pricing and terminology, which can create problems when comparing accounts, finding suitable processing, and pricing long term. Here we look at the interchange rates and what they mean to businesses when it comes to costings.

Merchant Service Charge (MSC) is made up of three factors: the interchange rate, acquiring fees (payment processing bank) and scheme fees (Visa and MasterCard). The interchange rate is often talked about in payment processing as it’s one of the pricing formats charged to merchants, we’ll look at that in more detail shortly.

Put simply, interchange rates are the fees that the acquiring bank (payment processor) pays to the issuing bank (customers bank) for handling each transaction.

Interchange fees are sometimes referred to as interchange reimbursement fees or interchange rates – it all means the same thing. The cost itself covers the overheads that the payment processor pays to the customer bank (issuing bank) these include;

• Handling costs
• Debt costs
• Risk factors

In one way or another the interchange costs are passed onto the business accepting card payments, regardless of the fee structure.

Whether switching merchant accounts or new to payment processing, interchange plus pricing might be a term you’ve come across (as well as blended and fixed costs). We’re going to focus on the interchange pricing for now and take a look at how each of them works.  There are two types of interchange pricing: IC+ (interchange plus) and IC++ (interchange plus plus).

Interchange + pricing breaks down the cost of processing transactions into two elements;

The interchange rate – the cost to the issuing bank (customer bank) for processing the transaction from the acquiring bank (payment provider) which is then passed onto you the merchant (transacting business).

The plus part – the acquiring fees (and profit margin) for processing the transaction, as well as scheme fees from Visa, MasterCard etc.

In this pricing set up both parts of the card payments fees will be listed on transaction statements which are issued every month for the previous month.

Interchange ++ pricing structure shows a breakdown of all three costs; the interchange rate, acquiring costs and scheme fees. Which is why its seen by many as the most transparent way of pricing. Merchants know the amount they are paying for each element of the transaction. All parts of transactional costings are listed on statements. There is a common misconception, that merchants prefer blended or fixed costings due to the complexity surrounding interchange pricing models. However, once stripped back the interchange pricing set up can be financially beneficial.

It’s worthwhile pointing out that interchange ++ pricing is available to large merchants processing over 50 million annually.

There are pros and cons of the interchange pricing model – as the cost of interchange are passed on directly to the merchant, this means that overall transaction costs can fluctuate, via the ‘pass through’ model.

However, for larger businesses especially the pros of interchange pricing models are transparency around each cost and the profit margins the payment service provider makes. This allows negotiation should you wish to switch accounts.

Despite the way both pricing structures are published – merchants are paying for the same factors within the transaction costs; interchange, acquiring costs and scheme fees. The difference between the two is that the blended pricing is wrapped up into one overall cost. For this reason, some merchants prefer blended pricing, as they know where they stand and can forecast card payments overheads. 95% of merchants in the UK are on a blended pricing model. Interchange plus pricing offers transparency for higher turnover merchants, with each fee broken down into an individual cost – the interchange element being passed on directly to the merchant.

There are some factors which influence the interchange rate, here’s a basic outline to help you understand;

Scheme fees – interchange costs vary between scheme providers (Visa, MasterCard etc) which means you will not pay the same amount of interchange across the board.

Payment methods – interchange overheads are higher for card not present transactions in comparison to face-to-face (card present) transactions. Examples of this include MOTO payments and ecommerce. The reason for this is fraud risk is lower when the card is present at time of payment, i.e. chip and PIN terminals.

MCC – merchant category code – each industry type is given a four-digit merchant category code which enables banks to establish the risk surrounding accepting card payments on behalf of that merchant. Higher risk merchants carry higher interchange costs.

Location – international merchants and transactions pay higher interchange cost.

Commercial Vs Consumer – consumer credit and debit card transactions are cheaper when it comes in interchange costs (and acquiring fees) than commercial cards.

Rewards cards – AMEX and alternative rewards cards have higher interchange costs, this is to account for the benefit offered to the customer when they spend on these card types.

Interchange fees are passed on directly to the merchant – which means there is no profit margin included from the customer bank. Being referred to as wholesale rates, this also means that interchange costs are non-negotiable.

If you are looking to save transaction costs cheaper fees may be available by reducing the acquiring costs, you can either do this directly or look at using a non-biased broker to help.