Today’s consumers are increasingly moving away from cash as the primary form of payment. According to the Federal Reserve Bank of San Francisco, credit and debit cards combined to account for just over half of all transactions in 2018 (51 percent). This trend has had a major impact on merchants, who must set up the payment gateway systems in order to process those payments. They must also learn to navigate the challenges that come with payment processing fees.
What is a Processing Fee?
Processing fees are service charges paid to cover the overhead costs and risks involved with credit card transactions. To understand how fees are calculated, it’s worth taking a moment to review what actually happens during a credit card transaction. The seemingly simple act of accepting a credit card payment is actually a complex, multi-step process involving multiple parties.
When a customer presents a card for payment, the business’s merchant gateway system submits the payment information to a payment processor, which then forwards the information to the card association that issued the card (such as Visa or MasterCard). From there, the card association refers to the bank that issued the customer’s card. The bank either approves or declines the transaction, and the decision flows back through the processing chain to the point of sale. If the transaction is approved, the merchant receives an authorization number to complete the sale. If the transaction is declined, the customer will have to present another form of payment.
All of this happens within seconds thanks to complex processing networks that connect merchants to card associations and issuing banks through merchant account providers or payment processors (which are often the same company, as with Transcend Pay). Although the process can be a little more complex and the actual processing of payments isn’t fully complete until credits and debits are issued between institutions to transfer funds, this broad overview is enough to provide context for how fees work.
Interchange Rates vs Processing Fees
Fees can vary dramatically based on a range of factors, but for most businesses, they consist of two key factors: the interchange rate and the processing fee. The interchange rate is a non-negotiable fee paid to the credit card issuer to cover the cost of network infrastructure and credit risk. Processing fees, which are sometimes called processor markups, are paid to the merchant account provider or payment processor for connecting the merchant to the credit card network. Like interchange rates, they cover infrastructure costs and credit risk, but unlike interchanges, they are typically negotiable and can vary from provider to provider.
Interchange fees are largely fixed based on overhead costs, but they are also adjusted for risk. The way in which payments are processed are a factor. In-person transactions are generally considered lower fraud risk than card-not-present (CNP) transactions (such as online, phone, or mail order purchases). Any transaction in which the credit card number must be keyed in typically carries a higher interchange rate. Debit cards with PINs are both lower fraud risk and bypass credit card association fees, which qualifies them for a lower interchange rate.
The merchant classification matters as well when determining the issuer’s interchange fee. Every business is given a four-digit merchant category code (MCC) that is used to segment it into a specific industry for simplified tax reporting. This is also what issuing banks use to identify the level of risk each business represents. Certain industries are classified as “high risk,” which indicates an increased likelihood of returns, chargebacks, or liability. High-risk merchants are typically charged higher interchange fees to account for these possibilities.
How Payment Processing Fees Affect Your Business
As a merchant, you’re typically responsible for covering everyone else’s costs in the credit card processing chain. Since interchange rates are non-negotiable, your choice of payment processor will have a major impact on how much you’re actually paying for each credit card transaction. It’s important to understand how your processor charges fees in order to make the best decision maximizing your revenue.
A reputable payment processor should always be transparent about what fees are being charged and when. Watch out for additional hidden fees that are tacked on as monthly costs, such as customer service fees, hosting fees for POS systems, or network access fees. Processors of dubious reputation often try to obscure fees by rolling them into a tiered or bundled pricing model that set certain criteria for different levels of transactions and charge different prices accordingly. These practices can unfairly cut into your revenue and make it difficult to make decisions based on your processing needs.
5 Tips for Minimizing Payment Processing Fees
Given the impact that fees can have on your business, it’s always a good idea to be thinking about ways to either avoid or minimize them. While some processing fees are unavoidable, there are steps you can keep them low.
1. Accept Cards in Person When Possible
While this obviously isn’t possible for many online businesses, in-person transactions carry a lower processing fee because they are less susceptible to fraud. Try to avoid taking credit card payments over the phone and do whatever you can to encourage customers to charge their purchases in person.
2. Require a Minimum Amount for Credit Card Sales
Each transaction is subject to processing fees, so a large number of low-volume transactions can quickly rack up a substantial amount of fees. Setting a minimum purchase amount for credit card sales can help minimize these fees, but there are a few legal caveats to consider. Federal law permits merchants to require up to a $10 minimum for credit card payments, but they must treat each card type the same (so you can’t have a $10 minimum for American Express, which has higher interchange rates, and a $5 minimum for Visa). Debit cards, however, may be subject to different rules depending upon the issuer, so check with your payment processor to see how much flexibility you have with setting minimums.
3. Minimize Chargebacks with a Credit Card Authorization Form
A chargeback occurs when a customer disputes a charge from your business and asks their card issuer to reverse it. High-risk businesses typically experience a higher than average volume of chargebacks due to the nature of their industry (it’s one of the key factors that gets them labeled as high-risk merchants in the first place). One way to minimize chargebacks is to use a credit card authorization form, which is a document signed by the customer that gives you permission to charge their card. Having this documentation increases your odds of winning chargeback cases with the card issuer and lowering the overall number of chargebacks your business experiences to keep your processing fees low.
4. Use an Address Verification Service (AVS)
One of the most effective tools in combating credit card fraud, an AVS requires customers to enter their address during the checkout process. When the transaction is processed, that address is checked against the address on file with the issuing bank. Businesses that implement AVS on their eCommerce platforms often qualify for lower interchange rates from credit card issuers.
5. Find a Better Payment Processor
Some payment processors engage in predatory behavior that forces businesses to maintain needlessly high reserve requirements and pay an assortment of fees for services that any reputable processor should be providing as part of their baseline services. High-risk merchants often face significant hurdles when setting up credit card processing because the processor may require them to meet additional requirements. When negotiating with a payment processor, always verify how their fee structure works and whether or not they deduct any percentage of transactions to meet a reserve requirement.
Reduce Your Payment Processing Fees with Transcend Pay
At Transcend Pay, we believe that transparency should be a core business value when it comes to payment processing services. That’s why our merchant payment gateway delivers versatile credit card processing to high-risk merchants with no reserve requirements or hidden fees. The best way to win your trust is to give you the tools you need to manage your payments and see where your money is going after every transaction. Whether you’re using our dedicated payment gateway, linking your existing portal to our system with our robust API, or installing the easy-to-use Tpay platform on your merchant website, we give you plenty of ways to take payments faster and grow your business.