To understand Interchange you must first understand how the system of credit card payment acceptance works. As a business it is important you know the economic model underlying payment card transactions because you are a key component in it.
There are 6 main entities involved, as laid out in the diagram below:
The merchant is the store, restaurant, retailer, or other business that accepts credit card payments.
The cardholder is a consumer who chooses to use a credit card (Visa, Mastercard or other) to make purchases.
An Issuer is the bank or financial institution that provides the consumer with a Visa-branded or Mastercard-branded card that the cardholder uses to make a purchase. When a credit card is used, what is actually happening is the Issuer is paying for that purchase on the consumer’s behalf to be repaid later, essentially lending the consumer money for them to do the transaction.
The processor (Discount Payments in this case) is the company that simplifies the complexity of payment acceptance for the merchant and provides a single point of contact into the whole system. They provide merchants with the equipment needed to accept credit card payments, they administer the merchant account, and provide provide customer service.
An Acquirer is the financial institution that provides the merchant account, exchanges funds with Issuers within a card payment network on behalf of the merchant, and pays the merchant for its payment card activity on a daily basis. The arrangement is something similar to extending the merchant a line of credit because Acquirers are at risk for every dollar that passes through the merchant account during a 6 month period. The 6 month period comes from the fact that this is the length of time available for a consumer to dispute a charge from a credit card transaction, also known as a chargeback. If the merchant doesn’t have the money to refund charges, the Acquirer is on the hook for it. This is why an application process exists to open a merchant account; to satisfy the underwriters’ concerns about the underlying risk.
The card brands (also known as card associations or networks) are global technology companies that connect businesses and financial institutions to provide fast and secure electronic payments. The most popular ones are Visa and Mastercard.
Simply put, Interchange is the cost processors pay on the transaction when a merchant accepts a payment - that’s why Interchange Plus pricing is also referred to as Cost Plus. You can think of it as the wholesale buy-rate of credit card processing. Every processor - whether it’s PayPal, Square, the payments arm of a big bank like Chase Paymentech, or Discount Payments - has to pay these fees and they all pay the same rates because the rates are dictated by the card networks (also called Bard Brands), the most popular being Visa and Mastercard. You can learn more about Interchange directly from Visa and Mastercard.
So that’s straightforward enough. Where it gets confusing is that Interchange isn’t just a single set rate, there are hundreds of different Interchange rates. What rate will be charged on a transaction? There are three main factors that ultimately decide what the rate will be for a transaction in question.
The first is how the credit card transaction is being processed. Electronic transactions where the card is swiped or the chip inserted have a certain rate, compared to a slightly higher rate for transactions where the card isn’t present like if you were to take an order over the phone or in the case of online purchases.
The second factor is what category of business you are. The card networks decide groupings for different types (industries) of businesses. For example, charities pay a lower rate than restaurants, but restaurants pay a lower rate than most other retail business types. More specifically, one of Mastercard’s categories is the Independent Business Everyday Spend category. They created this category to encourage electronic payment acceptance in sectors like restaurants, bakeries, pet stores, dollar stores, etc. where there is a high concentration of independent small businesses that consumers visit regularly and have low average transaction size. Visa has a similar category called Everyday Needs.
The third and final criteria that decides the Interchange rate of a transaction is the card type. There are many different types of credit cards from starter cards with low limits and few benefits to cash-back and rewards cards that offer fancy benefits like travel, insurance and much more. Depending on the card, the Interchange rate will be higher or lower.
Visa and Mastercard publish their Interchange rates publicly for all to see, and you can go explore them for yourself in the documents above. However, we know all these rates and categories can get complicated and overwhelming so that’s why we make it simple - just reach out and we'd be happy to do an apples to apples cost comparison.
The card brands (Visa, Mastercard, etc.) set the rates for interchange but they do not make the money collected from these fees. The Interchange fees are paid to the Issuer of each card. The Issuer is the bank that provided the consumer with a Visa-branded or Mastercard-branded card that the cardholder then used to make a purchase. When a credit card is used, what is actually happening is the Issuer is lending the consumer money for them to do the transaction. Interchange is named as such because it is the fees paid for interchanging money between the issuing bank and the acquiring bank. The acquiring bank (acquirer) is the financial institution that makes it possible for merchants to accept credit cards and pays them for those transactions.
To summarize, the Issuer and Acquirer represent the two halves of a transaction. The former interacts with the consumer (cardholder) and the latter with the merchant accepting a payment. The card networks are global technology companies that connect everything in over 200 countries to enable fast, secure, and reliable electronic payments. These card networks set the Interchange fees that Issuers make in a manner that balances the value delivered by Issuers and the benefits of accepting electronic payments. If the rates are too high, retailers won’t accept their cards - similar to what is seen in many instances with regards to American Express. If the rates are too low, financial institutions wouldn’t have strong enough incentive to issue cards.