Merchant Accounts 101

Everything You Need to Know to About Merchant Accounts

Author: Jim Conners

Rating: 10.0

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Processing Fees

Naturally accepting credit cards is not a free service. In fact, this may be the one service that has the most middlemen! Every time you accept a credit card the following people all receive a fee from the transaction:

Card Issuing Bank (they get the biggest cut)
Card Association
Acquirer
Processing Bank
Member Service Provider / Independant Sales Organization
Sales Agent

It's this fee that makes establishing merchant accounts so lucrative. Although the fee each entity above receives is minute, when you have millions of cardholders making purchases at millions of business the numbers add up very quickly. So who gets to pay these fees? The merchant. Why? Because they are the ones in least in the position to ignore credit cards. Consumers can use another form of payment quite easily. But merchants need to accept credit cards if they wish to stay in business.

How fees are charged can get very complex and we won't try to explain it all here. But as a general rule you can get charged fees under these circumstances:

Each transaction
These fees are charged every time you accept and process a credit card transaction of some kind. Examples include the qualified rate and authorization fee.
On a recurring basis
These fees occur on a set schedule and usually are not dependent on your credit card processing usage. Examples include a statement fee and annual fees.
One time based on a special situation
These occur only when certain criteria are met and otherwise are not charged normally. Examples voice authorization fees and monthly minimums.

This article focuses on Visa and MasterCard's rates as they are the most complex as well as the most common fees most merchants will experience. They are based on Interchange which is explained below.

Interchange

Interchange is the clearing and settlement system where data is exchanged between the credit card processor and the card issuing bank. It is a part of Visa and MasterCard. Most communication that occurs between the cardholder, the merchant, the card issuing bank and the Acquirer or Member Service Provider (MSP) must go through Interchange (such as transactions, deposits, chargebacks, etc).

Interchange sends transactions that occur at the merchant level to the appropriate bank for posting, sends funds to the appropriate Acquirer for payment, and assigns a qualification level for each transaction. The qualification level determines what rate the merchant will pay for the transaction and is based on whether the merchant met the Visa/MasterCard standards set for the level. Different rates, or costs, are associated with the different Interchange programs. Visa and MasterCard, periodically redefine these standards, or qualifications.

Qualified Rate

The qualified rate is the lowest rate a merchant can pay for any transaction. To "qualify" for this rate the merchant must meet a set of criteria. The criteria will vary by style of account and type of business. For retail businesses, typically the merchant must swipe the credit card through their credit card terminal or POS system and answer all terminal prompts. For an Internet merchant this may mean capturing and verifying AVS and CVV. If a merchant fails to qualify their transaction they may pay a higher rate (see the section titled "Surcharges" below for more information).

The qualified rate is the fee most likely to be charged to the merchant and thus is the rate advertised by merchant account providers. Once again, this isn't the only rate you may pay. It is just the most common.

Here's an example of a qualified rate being applied to a transaction:


Transaction dollar amount: $35.00
Qualified rate: 1.69% + 25¢


(First calculate the percentage)
35 x 1.69% = 59¢


(Then add the transaction fee)
59¢ + 25¢ = 84¢

In the above example a merchant with a ticket of $35 would and qualified rate of 1.69% + 25¢ would pay 84¢ for that transaction. But what if their sale was for $65? Let's see:


Transaction dollar amount: $65.00
Qualified rate: 1.69% + 25¢


(First calculate the percentage)
35 x 1.69% = $1.10


(Then add the transaction fee)
$1.10 + 25¢ = $1.35

As you can see the cost for that transaction is larger then the transaction for only $35. This is due to the percentage rate (1.69%). As the transaction grows larger so does the amount of that transaction dedicated to their qualified rate. If their transaction was smaller then $35 their overall costs would be smaller as well.

To see how rates and fees are calculated for any average ticket price be sure to check out our Basic Fee Calulator or Advanced Fee Calulator. They allow you to determine your costs based on your rates and average ticket price.

To compare the offers of multiple merchant account providers be sure to use our Basic Rate Comparison Calculator or Advanced Rate Comparison Calculator. These tools will tell you how much each account will cost you over the course of an entire year.

Transaction Fee

A transaction fee is a flat fee charged each time a successful transaction is processed. This mean the transaction fee is not charged if a transaction is declined. Only an approved transaction will incur this fee. In the above examples the transaction fee was 25¢

Authorization Fee

An authorization fee is very similar to a transaction fee except this fee is charged with every transaction regardless of the results of the transaction. This includes declined transactions. Essentially each time your credit card terminal, POS software, or payment gateway communicates with your processing bank this fee is charged.

Transaction Fee vs Authorization Fee

So which fee am I being quoted? Good question. This will vary by merchant account provider so you need to ask which fee you are being quoted before you begin the application process.

Blended Rates

A blended rate is nothing more then a fee, either percentage based or a flat rate, that combines the qualified rate and transaction fee. So instead of having a traditional structured rate such as 1.79% + 25¢ per transaction that merchant might pay a flat percentage of 2.50% or a flat fee of $1 per transaction.

Blended rates are calculated by taking a merchant's average ticket and determining what their fees would be for that sale. That cost then becomes the blended rate for that merchant. Here's an example of a flat blended rate:


    Average Ticket Price: $40
    Qualified Rate: 1.79% + 25¢
    

    (First calculate the percentage)
    40 x 1.79% = 72¢
    

    (Then add the transaction fee)
    72¢ + 25¢ = 99¢

In the above example a merchant with an average ticket price of $40 and a qualified rate of 1.79% + 25¢ could have a flat blended rate of 99¢. What if that merchant wanted a flat percentage rate? Well, we would continue using the above example and take it a step further:

(Take the flat rate and determine what percentage of the $40 it is) .99 / 40 = 2.48%

All we needed to do is find out what percentage of $40 99¢ is and we have our flat percentage rate.

Blended rates may seem like a good idea but in reality they're not. When you stop and think about it the fees will be exactly the same as if the rate wasn't blended. After all, the blended rate is based on your average sale. So you won't be saving any money which is naturally your goal. To make it worse, you may lose out with a blended rate. Let's say your average ticket were to suddenly rise to $50 per transaction. Here's a comparison of your old rate (1.79% + 25¢) versus your new blended rate (2.48%):


    (Find out what our blended rate will cost on a $50 transaction)
    50 x 2.48% = $1.24
    

    (Next, find out what our old rate will cost)
    50 x 1.79% = .90 + .25 = $1.15

The difference is 9¢ per transaction. That doesn't seem like a lot but when you multiply that by the number of transactions you do per month, which may be hundreds or thousands, suddenly it doesn't seem so small. Imagine if your average ticket becomes $60 or more!

To make it worse, merchant account providers understand that if your average ticket were to suddenly change they could lose money. So they pad the blended rate to account for such a contingency. Thus, you may lose out even if your average ticket stays steady. Blended rates seem attractive at first but when you look closer they offer no real advantage.

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