Choosing a credit card processor can cost you if you don't know what to look for, and, more importantly, what to avoid.
Talk to any business owner about credit card processing, and you’ll almost certainly hear complaints about the cost and the complexity.
It’s true that taking credit cards can be expensive, but many businesses actually pay much more than necessary.
Credit card processors have trained you to shop for processing backward, and if you’re like most people, you’ve taken the bait hook, line, and sinker.
If you’re shopping for processors based on vague factors such as who offers the lowest rates, the most savings, or the simplest pricing, you’re setting yourself up to overpay. The reality is that low rates are expensive, savings aren’t always savings, and simplicity will cost you.
Let’s look at each of those factors in more detail.
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Low Rates Are Expensive
When most people shop for credit card processing, they call a bunch of processors and ask each one the question, “What’s your rate?” Then, they choose the processor with the lowest rate. After all, the processor with the lowest rate will have the lowest cost, right?
This assumption couldn’t be farther from the truth. In fact, more often than not, the lowest rate is the most expensive overall. The amount you actually pay in credit card processing fees is always significantly more than the low rate you were quoted.
For example, let’s say a processor quotes you a rate of 1.59 percent, but when you begin processing, you find that the total amount you’re paying is closer to three percent. What happened to the 1.59 percent that you were promised?
Welcome to the shell game of credit card processing. The processor knew all along that you were going to pay more than 1.59%. That low rate simply entices you into signing up. It’s a classic bait-and-switch sales tactic where the low rate only applies to a small portion of your transactions.
Low Rate vs. Low Cost
A low rate has nothing to do with low cost because processing cost is not dictated by a processor’s rate. Total processing cost is comprised of three separate parts: the processor’s cost, the bank’s cost, and the credit card companies’ cost.
Card-issuing banks (such as Chase and Citibank) set the price for each type of transaction through something called interchange. The banks collect interchange as their income for the transactions you process. The credit card companies (Visa, MasterCard) set additional pricing for each transaction through what’s called assessments, which they collect as their income.
Interchange and assessments are exactly the same for all credit card processors, and processors have no control over that cost. You can think of interchange and assessments as the “wholesale” cost of credit card processing. As with anything in business, the closer you pay to wholesale, the better.
You can view the interchange schedules for Visa and MasterCard by following these links:
You can view card brand assessments by following this link:
As you can see from the links above, there are hundreds of interchange “categories” that may apply, depending on details of each transaction.
Rates quoted by processors are often based on something called tiered, or bundled, pricing. Essentially, a processor makes up its own rates and then groups various interchange categories under that rate.
Typically, processors will create three different rates: qualified, mid-qualified, and non-qualified. The qualified rate is the low rate that the processor will quote you to try to win your business. (The mid- and non-qualified rates are higher and often not prominently disclosed.)
The processor will then choose to charge only some of your transactions at the qualified rate, and charge you higher rates for any transaction it decides aren’t “qualified.” One of the biggest problems is that not only does the processor get to choose which of your transactions it considers qualified or non-qualified, it can change the classification at any time.
Don’t accept any quotes based on tiered pricing
Instead, ask processors to quote fees based on a pricing model called interchange plus. Interchange plus separates a processor’s markup from the interchange (wholesale) cost, resulting in more competitive and transparent billing. If the processor tells you that they can’t quote on interchange plus, or that you don’t have enough sales to qualify, find another processor. Interchange plus does not have a minimum sales volume requirement.
Shop processors by comparing markup, not rates
Paying as little as possible in processing fees means paying the lowest markup over cost. Interchange is the “wholesale” cost of processing. Any fee paid over interchange is a markup paid to the credit card processor. The most competitive credit card processor is the one that will offer the lowest markup, not the lowest rate.
- A processor’s rates don’t dictate the cost of processing. Interchange does.
- Tiered pricing allows a processor to manipulate your processing costs by routing interchange through its own contrived rates.
- Request quotes from processors based on interchange plus pricing, not tiered pricing.
- Shop for the processor with the lowest markup over interchange (wholesale), not the processor with the lowest rate.
Savings Aren’t Always Savings
It’s a really bad idea to shop for processors based on promised savings. It’s far more accurate to shop for processors based on total markup. You know that credit card processing is expensive, and you probably think you’re paying too much in fees, but you don’t know exactly why. So, you naturally set out in search of a processor that promises the greatest amount of savings.
It seems logical, but I’ll bet the savings promised by a processor never actually materialize. The reason is because savings are subjective. In many cases, the processor creates an illusion of savings. Remember that tiered pricing I mentioned in the first part of this article? Tiered pricing conceals interchange cost, so a processor doesn’t actually know how much its cost would be by looking at a tiered pricing statement from another company (like your current processor).
If a processor doesn’t know its cost, it can’t accurately calculate markup in order to determine how much you would save. However, this minor oversight doesn’t stop most processors from promising a ton of savings.
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An Example of “Savings”
I’ll provide an example below of how the same numbers can be manipulated to show more or less a savings. Let’s say that a business processed $10,000 in a month and paid $300 in total fees, and this business is being courted by two credit card processors.
Processor A The first processor offers the business a transparent, competitive quote based on interchange plus with low markups. This processor provided the business with a savings analysis where it assumed that the majority of the business’s transactions involved commercial and reward cards, which have a higher cost at interchange, or wholesale.
Since this processor assumed a higher interchange (wholesale) cost, the current processor’s markup is assumed to be a lower portion of the total cost. For example, we’ll say Processor A assumed the interchange cost was $200, which means the current processor’s markup was $100.
Processor A offers a quote with a markup that would yield $50, which would result in $50 in total savings compared to the current processor. Processor B The second processor offers an opaque, expensive quote based on tiered pricing with high fees.
This processor provides the business with a savings analysis that assumed that the majority of the business’s transactions involved signature debit and core credit, which have a lower relative cost at interchange, or wholesale.
Since Processor B assumed a low wholesale/interchange cost, the current processor’s markup is assumed to be a higher portion of the total cost. For example, we’ll assume Processor B estimated interchange cost at $100, which means the current processor’s markup was $200.
Processor B then calculates its quote would yield a markup of $100, resulting in estimated savings of $100.
As you can see from this example, Processor B offers a less competitive quote with a higher markup but is still able to promise greater savings because of how it calculated the cost. That’s what I mean when I say savings are subjective. Unless the processor knows exactly what you paid in wholesale (interchange) costs and accurately uses that information, savings promises are guesses at best.
Don’t compare processors based on “savings”
Instead, compare processors based on the total markup over cost. Every processor’s base cost is exactly the same. The money earned over base cost is the processor’s markup. The most competitive processor is the one that offers the lowest markup.
- Tiered pricing conceals interchange costs, which makes it impossible to calculate savings with 100 percent accuracy.
- Processors often overestimate savings by underestimating the base/interchange cost on a current processing statement.
- Don’t shop for processors by the greatest savings, shop based on the lowest markup.
Simplicity Will Cost You
Don’t make the mistake of thinking simplicity equals low cost. They’re two very different things.
A new wave of payment processors known as aggregators has given rise to single-rate processing that appears attractively simple. For example, mobile payment processor Square charges a single rate of 2.75 percent for all swiped transactions while online processor Stripe charges 2.9 percent + 30 cents.
There’s admittedly a certain amount of appeal to one single rate, but it comes at a cost. A good rule of thumb in credit card processing is the simpler things appear, the more expensive they become. To repeat the very important point I’ve covered throughout this article: All processors have the same exact cost for any given transaction.
It doesn’t matter if a processor is using a tiered pricing model spread over twelve different rates, an interchange plus model, or a simple single rate of 2.75 percent. The cost of any given transaction is the same for all processors. What varies is how much each processor makes off of the transaction.
Your goal as a business is to pay the lowest possible markup over the processor’s cost. Simplicity does not help you accomplish that because you can’t tell how much is wholesale cost and how much is markup. If your transaction costs less at wholesale, you still pay the higher single rate, and your processor makes more money.
Think competitive, not simple
Interchange plus pricing appears complicated relative to a single-rate, but it has the potential to produce a much lower processing cost. Shop for processors that offer interchange plus pricing to ensure that you can see what you’ll pay at wholesale and as a markup.
- Simple does not equal low cost
- Shop for lowest markup over wholesale cost
When shopping for credit card processing, it’s possible to avoid common pitfalls that can cost you in the long run. The closer you pay to wholesale, the lower your costs will be. Be wary of processors that promise huge savings, because it’s easy to manipulate the numbers to make a quote look better than it is. Lastly, don’t confuse simplicity with competitiveness. Companies that offer single-rate quotes look appealing, but you’ll pay more for the simplicity.