Merchant Processing Fees Explained [2023]

October 11, 2022 by Irongate Payment Solutions

The digital payments industry is playing an increasingly important role in the global economy as credit card transactions make up a substantial portion of all in-person and eCommerce purchases. 

According to Research and Markets, the expanding credit card payments market realized a $477.63 billion valuation in 2021. By 2027, the market is expected to be valued at $762.16 billion, which represents a compound annual growth rate (or CAGR) of 7.80%. 

This article will help merchants obtain answers to FAQs about the various fees they’ll pay to process these transactions.

What Are Credit Card Merchant Fees and How Do They Work?

The term “merchant fees” refers to the processing costs for credit card and debit card transactions made by customers. These fees pertain to Visa, Mastercard, American Express, and Discover card payments (but not to PayPal payments). The issuing bank (also called the card issuer or customer’s bank) receives most of the merchant fees.

The merchant services provider (or payment processor) receives the merchant’s sales proceeds in a merchant account. After deducting the processor charges, the provider sends the net sales proceeds to the merchant’s bank account.

How Merchant Fees Work

Today, customers can use varied payment methods to pay for their purchases. Each time a customer swipes, dips, or taps their card, the business owner pays a merchant fee (or discount rate). This fee is composed of interchange fees, assessment fees, and the payment processor’s markup.

Merchants have long complained about being nickel-and-dimed by multiple account fees. In recent years, fees have risen even higher.

The latest fee hikes have mostly resulted from the drastic rise in eCommerce sales during the COVID-19 pandemic. Not surprisingly, online card fraud also increased during that period. Issuing banks likely raised their fees to help compensate for losses due to card fraud.

What Are the Components of Credit Card Processing Costs?

Merchants’ credit card processing fees are composed of three components. Each item represents a different portion of the fee.

Interchange Fees

The interchange fee (or wholesale fee) represents the biggest portion of the card processing fee. The credit card network sets this fee, which is determined by the interchange rate. The network remits the interchange fee to the bank (or other financial institution) that issues the customer’s card. The fee is designed to help reduce the bank’s transaction risk.

Assessment Fees

Credit card networks receive assessment fees for the use of their respective cards. Assessment fees help to cover the card networks’ operations.

Payment Processor Markup Fees

Each payment processor charges a markup fee for each transaction. This fee represents the processor’s commission. The markup fee is negotiable, and higher-volume businesses may be able to receive lower markup rates.

Types of Fees Your Merchant Service Provider May Charge

Merchants with every type of business pay transaction fees for cardholder credit card transactions. Credit card processors can also hit a small business with additional fees. These payment processing fees include (but are not limited to):

Set-up fee: The merchant service provider may charge for in-person or phone-based account set-up.

Hardware fee: Brick-and-mortar business owners require a POS system, card terminal, and/or card reader. Some providers include this equipment in a promotional offer while others charge a fee. Leasing equipment is excessively expensive and is not recommended under any circumstances.

Payment gateway fee: eCommerce stores need an electronic payment gateway to process online payments. Some providers include free payment gateway access while others charge a payment gateway fee.

Virtual terminal fee: A virtual terminal enables manual data entry for phone orders. Some credit card processors charge a fee for the virtual terminal.

PCI compliance fee: The PCI compliance fee pertains to the merchant’s compliance with the payment card industry data security standard (or PCI DSS). Some providers charge merchants for compliance while others include it in the business’ monthly fees.

Address verification fee: Merchants can pay for an optional address verification service. Here, the store associate can complete a customer’s address validation before approving a transaction.

Monthly minimum fee: Some merchants may not achieve a predetermined monthly sales volume (or processing volume). In that case, they may be hit with a monthly minimum fee.

Statement fees: A merchant services provider may charge for generating monthly statements. The statement fee may apply to online or paper statements.

Chargeback fee: If a customer disputes a completed transaction, the merchant may be assessed a chargeback fee. Merchants should protect themselves against expensive chargeback incidents.

IRS reporting fee: Certain merchant providers assess a fee to report merchants’ transactions to the IRS. If the fee appears on a merchant’s statement, they should dispute it.

Early termination fees: If a merchant exits their contract early, they will likely be charged early termination fees (or ETFs). ETFs of several hundred dollars are common. Just so you know, Payment Depot does not charge early termination fees to its merchants.

What Are the Average Credit Card Processing Fees?

Determining the average credit card processing fees is not an exact science. Multiple factors come into play, some of which are outside the merchant’s control.

First, a merchant’s answer depends on whether they are a high- or low-risk business. The credit card type and payment processor’s pricing structure are also major factors. Merchants should also consider the type of transaction they process most frequently. Finally, their average transaction amount helps to determine the card processing fee.  

With that said, average credit card processing fees range from 1.5%-2.9% for card-present swiped transactions. Online transactions carry a higher card fraud risk, giving them a 3.5% average card processing fee. Here are the average fees for the four major credit card companies:

Visa:

1.4% – 2.5%

Mastercard:

1.5% – 2.6%

Discover:

1.55% – 2.5%

American Express:

2.3% – 3.5%

For perspective, debit card transactions have a different fee structure. Merchants pay lower fees when a customer uses their debit card. The funds come directly from the customer’s checking account so there is less risk compared to credit card payments.

Understanding the Different Pricing Structures

Each merchant services provider offers a different pricing structure. A specific processing company may offer two or more pricing models.

Interchange-plus Pricing

Many small- and medium-sized business owners choose transparent interchange-plus pricing. Here, card networks’ interchange fees (derived from interchange rates) are separated from the payment processor’s markup fee. This may facilitate easier integration into the business’ QuickBooks accounting software. This pricing model may be a good option for most companies with at least a $5,000 monthly processing volume.

Flat Rate Pricing

In a flat rate pricing structure, each type of card receives an identical processing rate. Therefore, all transactions are assessed the exact same flat fee, making it easy to estimate costs. A flat rate provider generally does not charge extra monthly fees, but transaction costs may be higher. This option may suit a business with small ticket sizes or lower monthly volumes.

Tiered Pricing

A tiered pricing structure includes three pricing tiers. Each tier offers a flat rate based on the type of card:

• Qualified rates: Apply to debit cards and non-rewards credit cards.

• Mid-qualified rates: Apply to standard rewards credit cards.

• Non-qualified rates: Apply to premium credit cards along with card-not-present card transactions.

Unfortunately, most transactions fall into the mid-qualified and non-qualified categories, which carry higher rates. In addition, the company probably won’t provide any explanation of the factors behind the classification. Overall, merchants will pay higher fees, so this model is not recommended.

Subscription Pricing

With a subscription (or membership-based) pricing model, merchants pay a monthly fee. This also includes most credit card processing fees, and merchants pay a very low markup fee. High-volume businesses will benefit from a subscription pricing structure.

How Can Small Businesses Lower Credit Card Processing Costs?

Many cash-crunched small businesses seek ways to decrease credit card processing expenses. These methods may help.

Adopting Other Cost-Effective Payment Methods

Many customers have their own payment method preferences. Merchants should offer multiple payment vehicles that accommodate customers while improving the business’ bottom line.

Discounted Cash Payments

Merchants can offer enticing discounts for cash purchases. Business owners should ensure that the posted item price is the regular price.

Debit Card Transactions

Merchants can suggest that customers pay with their debit cards. Debit card transactions offer substantially lower interchange rates. Therefore, merchants pay less to process these sales.

ACH Payments

Merchants can accept Automated Clearing House (or ACH) payments from customers. ACH funds are deducted straight from the customer’s bank account, and transactions process very quickly. Processing rates are also extremely low. However, the ACH underwriting process is more complex compared to the credit card underwriting sequence.

QR Code Payments

With a QR code payment method, a customer first scans the code with their smartphone. Next, they send an online payment that bypasses the payment processing hardware requirement. eCommerce sales lend themselves to QR code payments. In a brick-and-mortar store, merchants can print the code and make it visible to customers.

Additional Fee Reduction Tactics

Merchants can use several more strategies to reduce payment processing fees. Using multiple tactics will increase each business owner’s potential savings.

Establish a Minimum Credit Card Charge

Merchants can establish a minimum credit card purchase amount. This amount, which is allowed up to $10, means merchants won’t pay high transaction fees for very small purchases.

Use Credit Card Tokenization Technology

Merchants should ensure that their payment processor accepts tokenization-based payments. These more secure card payments substitute a digital token for the customer’s card number. Only the payment processor can decode this token and process the transaction. These transactions incur reduced interchange fees.

Avoid Higher-Fee Keyed Transactions

Merchants should only key in a transaction if the customer’s card simply won’t go through. Keyed-in transactions are charged a substantially higher processing rate.

Use the Processor’s Payment Gateway

Merchants who need a payment gateway should use their payment processor’s offering. Most providers don’t charge a payment gateway fee. If they do, it should be lower than a third-party payment gateway fee.

Minimize Credit Card Chargebacks

Chargeback fees for disputed transactions can be expensive. Excessive chargeback rates can cause payment processors to raise a merchant’s transaction fees. To minimize chargebacks and reduce fraud liability, merchants can use chip card readers and contactless payments. Stellar customer service and concrete return policies are also steps in the right direction.

Add Optional Fraud Protection Tools

Retailers (including eCommerce merchants) should consider optional fraud protection tools. Visa and Mastercard extend lower interchange rates to merchants using an address verification service (or AVS) tool.