Should You Be Using Interchange-Plus Pricing to Process Credit Card Payments?

Should You Be Using Interchange-Plus Pricing to Process Credit Card Payments?

Recently we updated our interchange-plus credit card processing pricing model and I thought I should say a few words about how this type of pricing works. We have written about interchange-based models a couple of times before on this blog, but based on the feedback we get, it seems like we need a refresher.

What Is Interchange?

In the payment card industry, interchange is a fee that a processing bank pays a card issuing bank for a transaction involving a MasterCard or Visa card. The interchange is a composite fee, made up of a percentage and fixed-amount components, for example 1.80% + $0.10 (so in this case the interchange fee for a $100 transaction would be [1.80% x $100] + $0.10 = $1.90).

Interchange fees are set by Visa and MasterCard and are published on the two Credit Card Associations’ websites. Each Association uses dozens of different interchange rates, based on two major criteria:

  • Type of card used. Regular consumer types of cards get lower interchange than special cards like rewards, business-to-business, commercial, etc. Additionally, debit cards get lower interchange than credit.
  • Transaction setting. Payments processed in a face-to-face environment get lower interchange than not-face-to-face ones.

How Does Interchange-Plus Work?

The interchange-plus pricing model works by adding the processing bank’s fee, as listed in the merchant agreement, directly to the interchange fee. Typically, the processor’s mark-up is also a composite fee, made up of a percentage and fixed components.

So if a processor charges 0.25% of the transaction amount + $0.15 for its services, this fee would be added to whatever interchange rate each of the merchant’s transactions get. As there are dozens of different interchange rates, so there will be dozens of different fees the merchant will pay for its transactions.

Should You Be Using Interchange-Plus Pricing?

Many merchants feel uncomfortable with an interchange-plus pricing model, precisely because it lacks predictability. They have grown accustomed to two- or three-tiered pricing structures, where they know that transactions can only be processed at two or three different rates, respectively. Is it really necessary to make things more complicated than that?

Yes, it is, if you want to be saving money. To understand why, you should look at the two-and three-tiered models as attempts to simplify the interchange tables. To illustrate, let me explain how a tiered pricing structure is designed.

Assume that there are 50 different MasterCard interchange fees. The two-tiered model breaks them down into two groups, one containing the 25 lowest rates and the other containing the rest. The processor sets one rate, called “qualified” for the lowest-rate group and another, called “non-qualified” for the other group.

The crucial thing to understand is that both the qualified and non-qualified rates must be higher than the highest interchange in their respective groups. So if the lowest rate in the qualified group is 1.04% + $0.10 and the highest is 1.80% + $0.10, the qualified rate must be higher than 1.80% + $0.10. The same rule applies to the other group.

Now you can see that in a tiered model the rate your processor charges you can vary in a quite wide range. This doesn’t make sense, because a payment is processed in exactly the same way, whatever the applicable interchange. As far as the processor is concerned, all transactions are the same. So why should it get paid much more for one transaction that it is for another?

More to the point, why should you be paying your processor much more for some transactions than for others? See, there is nothing you can do about the interchange. It is beyond your control. It is well within your powers, however, to select a pricing model and to negotiate what your processor charges. As unpredictable as it may seem, the interchange-plus credit card pricing model is the one that lets you get the most of your negotiating position.

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