Who Pays What Of Credit Card Transactions

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The following is a guest post from www.MerchantCouncil.org – an unbiased site that helps merchants find the best merchant account for their business. While most of you are familiar with APRs, rewards and the typical stuff, I think this is an interesting look at the type of fees credit card issuers impose on merchants.

Many things happen behind the scenes to facilitate the process that’s initiated when a cardholder presents their credit card to a merchant as payment for goods or services. Balances are verified, authorizations are placed and funds are moved from one financial institution to another – and that’s only a brief summary. Cardholders and merchants each have very different views and responsibilities when it comes to using and accepting credit cards, but they have one important thing in common – the issuing bank.

When you use your credit card, your thoughts are probably focused on things like your current available balance and the APR on your account. These and other details of your account are set by the issuing bank of your credit card. That’s the bank that originated your card account, that lends you money to make purchases and the one that you send payment to each month. Some examples of large issuing banks are Bank of America and Citi Bank.

The businesses where you use your credit card to pay for products and services are also concerned about your issuing bank – but their thoughts are focused on something called the interchange reimbursement fee.

Issuing credit cards is a pretty profitable venture for banks that are large enough to handle the risks involved. On one side of the equation, they collect interest and other fees that are mainly a result of the APR on their cardholders’ accounts. On the other side of the equation, they collect interchange fees from the merchants that accept credit cards as payment from their cardholders.

If you’ve got a credit card you’re pretty familiar with interest rates and APR, but unless you’re also a business owner – you probably aren’t aware of interchange reimbursement fees and how they affect businesses.

Interchange rates are essentially the wholesale fees for Visa, MasterCard and Discover brand credit cards that a business must pay to a bank each time they accept a credit card issued by that bank. Interchange fees don’t apply to independent card brands like American Express – which I’ll talk more about later.

The stakeholders of Visa and MasterCard (which are primarily issuing banks) maintain something called an interchange reimbursement fee schedule that anyone can view by going to their respective websites (links below). These fee schedules dictate the percentage of a transaction that a business must pay to an issuing bank when they accept that bank’s credit card.

You’ll notice by looking at the interchange fee schedules that there are quite a few different categories – each of which can carry a percentage charge, a per transaction charge or both. This is done for a number of reasons that are beyond the scope of this article, but the fee is generally based on risk, a merchant’s processing behavior, or their business type.

Interchange is often quite confusing for merchants because there are so many different categories and reason why transactions fall under one category or another. It’s typical for merchants to have charges resulting from several different interchange categories in a single monthly billing period.

In addition to interchange fees, merchants also must pay assessments to Visa and MasterCard as well as a fee to their merchant service provider. With an average interchange charge of 2% and an assessment of 0.0925% imposed on each transaction, it’s no surprise that merchants spend plenty of time making sure that they have a cheap merchant account.

When comparing merchant accounts, business should look for either a flat rate merchant account or something called interchange plus pricing. Under this pricing model, a merchant service provider applies a fixed mark-up to the actual interchange charge as dictated by Visa or MasterCard. Interchange plus and flat rate pricing models are the best merchant account pricing structures a business can have for both cost-effectiveness and transparency.

Visa, MasterCard and Discover brand credit cards are referred to as bankcards because they’re backed by a number of actual banks. Brands that are wholly-owned and that are back by a single issuing (and acquiring) bank are called independent brands. Rising interchange fees for bankcards and large independents alike are creating opportunities in the marketplace for more independent brands to come up through the ranks – the latest of which is RevolutionCard.

Like the bankcard brands, independent brands dictate the charges that cardholders and merchants must pay to use and accept their cards. In the case of the largest independent card brand, American Express, a merchant generally pays a rate of about 2.5% per transaction to accept an American Express card as payment. American Express plays their cards (no pun intended) a little closer to their chest in terms of the rates and fees they charge.

Now that you have an idea of the costs associated with accepting credit cards, you can understand why many merchants impose minimums on credit card purchases, a convenience fee or other cost-mitigating strategies.

The most widely used practice among merchants to lessen the costs associated with accepting credit cards is to apply a minimum purchase amount to credit or debit card transactions. They do this to avoid losing money on transactions where the profit from the sale isn’t enough to cover the cost associated with processing it.

For example, let’s say you walk into a convenience store and a bottle of water for $1.59 and use your Visa card as a form of payment. The merchant’s cost for the bottle of water is $1.00, leaving them $0.59 gross profit. Of that let’s say that their operational costs total 50% of gross profits, leaving them with about $0.30 of NET profit in a typical transaction.

Since you’re paying with your credit card, the merchant will have to pay processing costs of roughly 2% for interchange, plus another 0.0925% for assessments, plus another roughly 1.75% and $0.20 for the merchant service provider’s fees. After processing fees, the merchant is left with less than $0.10 or just under a third of their initial NET profits.

To guard against this happening, some merchants place a minimum purchase amount on credit card sales, but doing so is against the agreement they signed with Visa and MasterCard. Merchants aren’t allowed to discriminate against cardholders for any reason – including the amount of a transaction. Businesses that are reported to Visa or MasterCard for violating their merchant service agreement may be fined, have their merchant accounts closed or both.

The next time that you’re in a store where you’re forced to a pay a minimum to use your credit card, consider a couple of options. You can pay cash for the transaction and be done with it. If you don’t have cash, you can point out to the merchant that they’re in violation of their agreement and ask for an exception. Lastly, you can threaten to report the merchant hoping that they’ll let you use your card for what is likely a purchase of less than $10.

Many merchants that get reprimanded for imposing minimums on credit card transactions are forced to raise their prices across the board for both cash and credit transactions. Keep that in mind before resorting to option number three above.

Resources

http://usa.visa.com/merchants/operations/interchange_rates.html
http://www.mastercard.com/us/merchant/support/interchange_rates.html

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