What to Look For, What to Avoid and When to Switch
Starting a business is exciting and scary, and it seems like there’s an endless amount of things to learn.
One of the most confusing topics for business owners is choosing a credit card processor: what pricing model is right, which company is the best, when should you switch to a different processor?
Whether you’re brand new to running a business or a seasoned owner stepping into the world of accepting credit cards for the first time, here’s what you need to know about choosing your first payment processor and the signs that it's time to graduate to a new one.
Related Article:10 Credit Card Payment Services for Small Business Owners
It’s Not About “Rates”
Many businesses make the same mistake the first time, or even the first few times, when shopping for a processor: they focus on “rates.” But rates are only one factor in the merchant account credit card processing equation and if you shop based on who has the lowest “rate” you’re setting yourself up for headaches, confusion, and overpaying.
Instead, start by evaluating your situation. Answer these two questions:
- What is your average transaction total?
- What is your average monthly credit card volume?
It’s okay if you don’t know exact numbers (a ballpark estimate will work) so write down your answers or keep them in mind as you move on to the sections below.
Understanding Processing Costs
There are three components to credit card processing costs: interchange, assessments, and markup. Interchange and assessments are non-negotiable; you can think of them as the “wholesale” cost of credit card processing. Interchange goes to the banks that issue credit cards to customers, while assessments go to the card brands, such as Visa and MasterCard. As with anything in business, the closer you pay to wholesale, the better.
Markup is the only part that’s negotiable (everything else stays the same from one processor to the next) and is what the processor charges (as profit) to handle your transactions for you.
How processors charge the wholesale costs and markup is determined by pricing model, with the three common pricing models known as flat rate, interchange plus, and tiered. As tiered pricing is the most opaque and the most expensive, I don’t recommend it. This article will instead focus on the other two pricing models (flat rate and interchange plus) which are superior for businesses, whether you’re choosing your first or your fifth processor.
With those basics in mind, let’s get back to your answers to the questions about your business.
If your average transaction total is less than $10 or if your average monthly volume is less than $3,000
If this is you, you’ll want to investigate flat rate credit card processing solutions. Flat rate credit card processing is what it sounds like – the processor charges you a flat rate to process credit card transactions on your behalf. A typical flat rate might be 2.75 percent or 2.9 percent + 30 cents.
With flat rate processing, all of the costs (interchange, assessments, and markup) are included in the flat rate. This makes it look simple but is only competitive for businesses that fit the profile described. Additionally, it isn’t possible to see what the processor’s markup is when you’re on a flat-rate model, so you can’t see how close you are to wholesale.
Square, Stripe, and PayPal are examples of flat rate processing companies.
If your average transaction total is more than $10 and your average monthly volume is greater than $3,000
If this is you, you’ll want to look for interchange plus credit card processing. Interchange plus pricing is often quoted as the markup only, such as “0.10 percent + 10 cents on top of interchange” or “interchange plus 0.10 percent + 10 cents.” That means that the processor is only charging you 0.10 percent and 10 cents on each transaction as its markup.
Other costs that you’ll be charged are the wholesale costs (the non-negotiable charges), which you’d pay with any processor. When you're charged on interchange plus processing, you’ll see the wholesale cost and the markup separately, so you can tell how close to wholesale you’re paying.
When to Switch
Businesses that are just starting out grow over time. Average transaction amounts and monthly volume may both go up as you gain new customers and increase sales. It’s perfectly fine to start out with a flat rate processor and then switch as your business grows. Here are some things to keep in mind about switching:
- Consider switching when your average ticket and monthly volume go up and stay up
This is particularly true if you use a flat rate processor. If you start processing more than $3,000/month in credit cards and have an average ticket above $10, consider switching to a more competitive interchange plus processor. You can use credit card processing comparison sites like CardFellow to see what pricing is available to you.
- Keep a close eye on contracts and termination fees
Some processors use automatically renewing contracts, so be sure you know when your current agreement is up and provide the required notice to the company. (It’s a good idea to send cancellation notification by certified mail.) If you want to end your contract early, you may have to pay an early termination fee. This article by business litigation attorney Nate Baber of Aeton Law Partners, LLP, provides a good starting point for understanding and avoiding cancellation fees, but be sure to consult your own attorney if you need specific legal advice.
- Don’t switch based on “low rates”
Remember from the beginning of this article, it’s not about “rates.” To get the best deal, you want to pay the lowest markup over the wholesale cost. When talking to the processor and getting a quote, the rep should be able to tell you the markup. If they can’t, or won’t it may be best to consider another processor.
Other Things to Avoid
There are many facets to credit card processing, but knowing a few “traps” to avoid can save you time and money. When shopping for your first processor, it’s easy to fall prey to common sales tricks and unfavorable pricing models. Two big things to avoid include:
Tiered or “bundled” pricing
Tiered pricing is the most opaque pricing model out there, and also usually the most expensive and the most frustrating for businesses. It’s best to just avoid it completely. You can tell that a processor offers tiered pricing if they have “qualified” and “non-qualified” rates for transactions.
Very rarely, processors may offer free equipment and a good deal on processing. More often, they’ll offer free equipment as a way to get you to sign up, but will overcharge you on processing to make up for it. As the saying goes, there’s no such thing as a free lunch. If a processor pushes free equipment, be sure to examine the pricing quote carefully since it’s very likely that you’ll be gouged.
Reviews. Especially paid reviews
It sounds counterintuitive, but credit card processor reviews aren’t very helpful, for one big reason: processing companies can set terms and pricing on a per-business basis. The pricing and service that the reviewer receives might not be the same pricing and service that you’ll get. To avoid that sort of situation, take reviews with a grain of salt, and be sure you know the motivation of the reviewer.
For example, does the review website get paid by the processing company? Instead of trusting reviews, consider using quote comparison sites, and focus on finding a processor that offers competitive pricing (as close to wholesale as possible) with beneficial contract terms, like no cancellation fee.
Starting a business always comes with mistakes, but following the advice above can help you navigate the world of credit card processing and make the right choice for your first payment processor.