What Determines the Cost of Interchange Fees?

If you own a business, and you want to accept credit card payments, you’re going to have to pay interchange fees.

There’s just simply no way around it. If you accept payments with credit cards or debit cards, your bill for payment processing is going to include these fees.

But despite the ubiquity of interchange fees, it’s safe to say that most business owners know very little about them.

What are interchange fees?

Who’s profiting from these fees?

What are the factors that determine their cost?

And why am I, as a business owner, responsible for paying them?

Many merchants are asking themselves these kinds of questions, and over the years, we’ve spoken with our fair share of business owners who have absolutely no idea how to answer them.

From our point of view, this confusion is completely unacceptable, and unfortunately, the banks and credit card companies aren’t making things any easier to understand.

That being said, we figured it would be in the best interests of business owners if they were made aware of all the factors that determine the cost of interchange fees.

So, if you’re confused about the cost of these fees, then you should definitely keep reading.

Because in this article, we’re going to break down everything that determines the cost of interchange fees, so you can have a better understanding of what’s showing up on your statement.

And if you have no idea what interchange fees are, or you’d like a little refresher, then you should check out our article on What You Need to Know About Interchange Rates in Canada.


How Is the Cost of Interchange Fees Determined?

Cost of Interchange Fees Determined

While it may seem convoluted, it’s actually pretty easy to understand how the cost of interchange fees is determined.

Truth be told, some of it is pretty arbitrary, but aside from the capriciousness of credit card companies, there are several other factors that determine their cost.

Below, you’ll find everything you need to know about how the cost of these fees is calculated.


The Rates Set by the Credit Card Companies

First and foremost, the cost of interchange fees is determined by the rates set by the credit card companies.

Typically, these rates are set twice per year, with Visa and Mastercard, for instance, setting their rates once in the spring, and again in the fall.

Sometimes, no changes are made, but typically they will adjust their rates at these regular intervals.

For example, in April of this year, Visa and Mastercard changed their rates.

Among other changes, Visa cut its interchange rate by 10 per cent for businesses that process less than $250,000 worth of Visa transactions annually, and Mastercard lowered its rates on small ticket transactions, as well.


The Nature of Each Transaction

Interchange fees are charged differently, depending on the nature of the transaction.

For example, card-not-present transactions, such as those done over the phone or online, tend to have higher interchange fees than those that are done in person, also known as card-present transactions.

Why is that?

Well, each credit card has a unique chip, and these chips are very difficult to replicate. In addition, each cardholder has their own PIN number, which only they should know.

This means that purchases made in person carry a much lower risk of fraud because if someone wanted to make a fraudulent transaction in this way, they’d have to steal a card, and figure out the PIN.

Whereas, if someone wanted to make a fraudulent transaction over the phone or online, typically, all they’d have to know is the credit card number, which is much easier to obtain than someone’s card and PIN number.

That being said, credit card companies set higher interchange rates on these kinds of transactions, as a way to compensate for the fact that they’re much more susceptible to fraud, and therefore much riskier.

At this point, many of you are probably asking, “But what about tap transactions, or those done with a cell phone or smartwatch?”

Well, typically these transactions are treated similarly to card-present transactions, as each one of these payment methods has its own built-in security features.

Although contactless credit cards don’t require you to enter a PIN, they still utilize chip technology, and typically, they only allow you to make purchases of $250 or less.

Transactions done with cell phones or smartwatches, on the other hand, have their own security features, including passwords, and biometrics like voice, fingerprint, and facial recognition.


The Kind of Credit Card Being Used

Aside from the rates set by the credit card companies and the nature of each transaction, another factor that determines the cost of interchange fees is the kind of card being used.

You see, things like business credit cards and rewards credit cards, which are becoming increasingly common, will have higher interchange fees, as well.

For example, most rewards cards will have interchange fees that are at least half a per cent higher than your run-of-the-mill credit card, if not more.

A standard Visa could run you 1.42 per cent, whereas a rewards card might cost 2.1 per cent. Some cards will even go as high as 2.6 per cent, but that’s actually pretty rare these days.

When it comes to rewards cards, the interchange fees associated with them tend to be significantly higher, in order to compensate for the cost of the rewards programs.

Business credit cards, on the other hand, are often used for larger transactions, which are considered to be much riskier, and therefore, higher fees are charged in order to offset that risk.

Also, credit cards issued by retailers such as Canadian Tire, Home Depot, or Walmart, for example, tend to have higher interchange fees associated with them, as well.

This can be chalked up to the fact that usually, these cards are issued by third-party providers, rather than banks or other financial institutions. At the same time, more often than not, they’re also associated with some sort of rewards program.


The Type of Business Accepting the Payment

Business Accepting the Payment

In addition to all the other factors listed above, the cost of interchange fees is also determined by the type of business that’s accepting the payment.

Some businesses will have to pay inherently higher interchange fees, while others will pay lower fees, based on the amount of risk they pose to the credit card companies.

Typically, this has to do with the amount of time between when the cardholder pays versus when they actually receive the corresponding product or service.

What does this mean?

Well, in the furniture industry, for example, customers don’t usually pay for an item and then walk out with it the same day, unless it’s something small like a lamp.

So, the customer will pay, a delivery date will be set, and it could be days or even weeks before they actually receive their furniture.

A lot can happen during that time, such as the product getting damaged during shipping, the cardholder finding a better deal elsewhere, or for whatever reason, changing their mind and cancelling the order.

When things like this happen, it often involves what’s known as a chargeback, which refers to when a cardholder disputes a charge on their credit card and asks the card issuer to reverse it.

Sometimes, this requires the credit card company in question to get involved in arbitration over the dispute, and this can eat up a lot of time and resources, hence the higher fees on credit card transactions in these kinds of industries.

Other businesses that are affected in this way include airlines or companies that do home renovations, as there’s usually a considerable amount of time between when their customers pay and when they actually receive the service they paid for.

Another industry that has to deal with higher interchange fees is the cannabis industry. It’s considered to be higher risk, not least because of the fact that this is a brand-new regulatory environment where governments are still testing the waters, and therefore, it involves a lot of uncertainty.

At the same time, some organizations that accept credit card payments tend to pay significantly lower interchange fees, such as non-profits, charities, and churches.

Aside from just being a gesture of goodwill, these organizations present a much lower risk for credit card companies, for a couple of reasons.

First of all, the payments they’d be accepting are usually instant transactions, such as donations, where no one has to deal with any of the issues associated with waiting to receive a product or service.

And obviously, the vast majority of people are not going to dispute a donation to a church or a charity, so these transactions are considered lower risk for that reason, as well.


Are you looking for a payment processing company that will take the time to ensure you understand everything you’re paying for? We are dedicated to providing absolute clarity for our customers. Give us a call today to learn more about what we can do for you.

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