When you see credit cards advertising cash-back incentives and valuable sign up bonuses, you might wonder how they can afford to provide such tempting offers, especially when the excellent credit users who qualify for these top offers generally pay on time, all together avoiding the high interest rates lenders bank on.
While interest charged on outstanding balances is indeed the number one money-maker for credit card companies, interest alone is not the only source of cash flow.
Lenders also benefit from collecting a range of fees — some you might be familiar with, like annual fees, late fees and balance transfer fees, and others may be less familiar, like interchange fees.
What are interchange fees?
Interchange fees are fees paid by merchants to the customer’s banks when debit or credit cards are used to make transactions — you also can think of interchange fees as “swipe fees.”
These fees generally range between 1 to 3 percent of each purchase and depend on the type of card used, the method of acceptance, the merchant category code and a number of other factors.
“Interchange fees cost the average American household an average of $400 each year.”
Interchange fees were originally introduced as a way to cover overhead costs and the risk of fraud incurred when cards are used for purchases. As such, the fee structure was built around perceived security risk.
For example, when buying online, the credit or debit card being used is not visually verifiable, therefore it is higher risk and carries a higher fee. When making a debit card PIN transaction, however, the lower risks translates to a lower interchange fee.
While the interchange fee is charged to merchants rather than consumers, it is often passed along to the customers in inflated store prices (which is why it never hurts to ask for a cash discount).
According to the National Retail Federation, interchange fees cost the average American household an average of $400 each year.
The current state of interchange fees
Interchange fees have been highly unregulated in the past, and because of the Visa/MasterCard monopoly, or rather, duopoly, the market price has been controlled and set by these two credit card companies for all merchants.
In contrast, American Express issues its accounts directly and governs its own rates, with fees ranging between 2.3 and 3.5 percent.
In 2010, the Durbin Amendment, part of the Dodd-Frank bill, capped interchange fees, limiting them to swipe fees that were “reasonable and proportional to actual cost.”
The Dodd-Frank bill also capped debit card swipe fees at 21 cents, kept credit card companies from interfering with cash discounts and allowed retailers to set minimum purchases for credit cards.
” … as a result of the Durbin Amendment, ‘There will be a transfer of $1 billion to $3 billion annually from low-income households to large retailers and their shareholders.'”
But even with the new regulations in place, the controversy over interchange fees continues to grow. Retailers site interchange fees as one of their top costs after employee salaries and health benefits.
The National Retail Federation in conjunction with the Merchants Payments Coalition is pursuing legislation to require companies to clearly disclose fees charged by each type of card and to create more competition to break up the Visa and MasterCard duopoly.
While most large retailers have seen significant cost reductions thanks to the Durbin Amendment, there is no evidence those savings have been passed onto consumers.
As for smaller retailers, interchange fees have increased as credit card networks have eliminated discounts previously given to make up for the loss in revenue from capped interchange fees.
According to a 2014 George Mason Law and Economics Research paper, it is estimated as a result of the Durbin Amendment, “There will be a transfer of $1 billion to $3 billion annually from low-income households to large retailers and their shareholders.”
Needless to say, interchange fees are a hot topic, and even if you don’t deal with them directly, the implications of these fees will undoubtedly affect your consumer experience.
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Editorial Note: Opinions expressed here are the author's alone, not those of any bank, credit card issuer, airline or hotel chain, and have not been reviewed, approved or otherwise endorsed by any of these entities.