Accepting cash is one of the original ways to accept payment face-to-face. Bartering came before that... However, credit cards are relatively recent developments.
For online businesses, their only viable option is credit cards.
The merchant services industry generates over a trillion dollars in revenues each year and many companies are cashing in on this. The number of companies and levels involved in merchant services is very complex and the multitude of entities involved serve to increase the cost of merchant services. Add to the mix that many of the providers do everything they can to hide the actually fees and costs. As a result, the merchants who are paying these fees typically have no idea how much they are paying to whom. In the end, the consumers of the products end up absorbing some of the cost, the merchant loses profit and somebody somewhere has made money on the transaction.
In truth most of the merchant service providers do not want you or anyone else to know how it all works. If the merchants understood the process and where then money goes, then they would not be so easily duped into paying junk fees and high processing costs.
The purpose of this training is to demystify all the fees and terms used to obfuscate the money trail. We will cover many areas of merchant services. The goal is to educate you about merchant accounts so you can provide superior service to the merchants you encounter.
Who the players are
We discuss who participates in the merchant services industry and what each of them do. We’ll begin with Visa and MasterCard, the credit card companies, and go down to you.
The basic elements of merchant accounts
Rates and fees – How and why they’re determined and charged. We will go over the environment in which credit cards are processed and the types of cards used and these variables impact merchant accounts and the fees charged.
Rates & fees
We won’t discuss the 30+ variable tables used by the card companies but we will cover the basics. The rates and fees are the most confusing part of a merchant account. Some fees are mandatory and forced by the card companies while some fees are used just to make money by others. There are also multiple names used for the same fee to make sure they are even less obvious. We will look at the most common fees and explain when and how they are charged.
These companies are the big players in the whole process. They own the cards, establish guidelines, and determine who gets a card and how merchants are able to accept the cards. Without the card companies there would be no need for merchant services or merchant accounts.
VISA (Visa International Service Association) and MasterCard are both payment processing institutions that are each owned jointly by thousands of participating financial institutions that issue and market VISA and MasterCard products (mainly credit and debit cards). Both companies have similar products. Other financial institutions issue cards that use either VISA or MasterCard for processing payments.
They set and enforce rules and regulations governing their bankcards, such as operational and Interchange procedures. They supervise the bankcard processing function within their members' banks.
They are also responsible for conducting clearing and settlement processing of credit card transactions through Interchange (the process involved in completing a credit card transaction. The "Interchange" refers to all organizations involved in the transaction, including processors, acquirers and issuers).
Combined Visa and MasterCard account for the majority of all credit card transactions.
American Express is not a credit card like Visa and MasterCard. Financial services corporation, which specializes in the issuance of credit cards to millions of individuals across the world. American Express provides a wide range of credit cards that are geared to the cardholders spending habits.
Unlike Visa and MasterCard, American Express is not comprised of member banks but is its own entity. This is why there is a separate application process for American Express for merchants who wish to accept it.
Discover Card was started by Sears and is the newest of the four major credit cards. Although Discover Card has more cardholders than American Express, in terms of processing it is by far the smallest of all of the major credit card providers. Like American Express, Discover Card is not comprised of member banks but is its own entity and also has a separate application process for Discover Card. Unlike American Express, however, Discover Card is now partnering with processing banks to have merchant accounts established just like Visa and MasterCard.
The card issuing bank is the bank that issues the credit card. They are a licensed member of Visa and MasterCard and can also be an Acquirer (see below). The Issuing Bank solicits,
The Acquirer provides credit card processing services to the merchant by acting as the communications link between the merchant and the card issuing bank. The Acquirer is a member of Visa and/or MasterCard network.
A Merchant Service Provider (MSP) or Independent Sales Organization (ISO) is a licensed broker of credit card services or banks through which business is processed. A MSP/ISO is usually an independent salesperson or company who contracts with a bank or a processor to sell credit card processing, equipment, and services to the merchant. The MSP/ISO sometimes provides back office functions such as settlement and chargeback/retrieval management, equipment-related customer service, paper storage and retrieval, and supplies. MasterCard originated the term MSP, while Visa uses the term ISO (Independent Sales Organization).
The cardholder uses the credit card given by the card issuing bank to purchase goods and services or to obtain a cash advance and receives a monthly bill from the card issuing bank. The cardholder is expected to sign the back of the card and limit its use to only authorized users, stay within the assigned credit limit, and pay the card issuing bank all or a minimum amount of the balance when the monthly bill is received.
The merchant provides goods and/or services to the cardholder. Visa and MasterCard require that the merchant be financially responsible, have acceptable credit rating and adhere to all rules and regulations set forth by them. The acquirer requires that the merchant adhere to the merchant processing agreement they signed that details the prices the merchant will pay for equipment, discount rates and fees. It also spells out the terms and conditions under which the merchant will conduct credit card business, such as the card types the merchant will accept, chargeback rights, and access to the merchant's bank accounts.
Processing Platforms, also known as Processing Networks, are the computer networks that electronic transactions occur over each day. There are multiple networks available for electronic transactions to occur over but the merchant does not choose which platform(s) they use. Each acquiring bank establishes relationships with the processing platforms they feel would be best for their business model (usually basing the decision on cost and availability).
Not all platforms are created equally. Each platform establishes a unique API (Application Programming Interface - It specifies how software components should interact with each other) for which software and equipment can communicate with it. Thus, software and equipment cannot use a platform to process electronic transactions until it has verified that it can support that platform's API successfully. As a result some software and equipment will only work on some platforms and not others.
When choosing a merchant account provider, some merchants will base their decision on the platforms that provider has available to them. This will typically be because the merchant has a specific piece of software or equipment that only works on a specific platform. An example would be restaurants that use proprietary POS software.
In the world of credit card processing, one size does not fit all. Businesses operate in different manners and this affects the kind of merchant account they will have. It is important for a merchant account provider to establish a merchant with the proper account during the application process as to prevent the many problems that can arise if the merchant is improperly classified. Having the proper merchant account not only helps to keep a merchant's rates to a minimum, thus saving them money, but also helps to protect against fraud and chargebacks.
A retail business is face-to-face with their customers and can swipe their customers' credit cards through a credit card terminal and process them in real time. Brick-and-Mortar retail stores are typical examples of a retail business but they are not the only ones. Merchants who have stands at flea markets can also be retail if they use a credit card terminal at their stand.
Businesses that are not face-to-face with their customers at the time of sale are classified as Card Not Present (CNP) accounts. These businesses typically take payment in any of the following manners:
The one thing they all have in common is that the merchant is not face-to-face with the customer at the point of sale. These transactions are usually keyed into a credit card terminal or POS software.
Another form of CNP business is merchants who perform recurring billing. Although the very first transaction may occur in a retail environment (face-to-face with the merchant and swiping the credit card through a credit card terminal) every recurring transaction afterwards will not be swiped. Because these recurring transactions comprise the majority of the transaction for this merchant they would be considered a CNP merchant.
An Internet business is very similar to a CNP business. The distinguishing characteristic between the two is how the customer's credit card information is acquired. An Internet merchant acquires their customers' credit card information through their website. The customer's information is physically captured and transmitted through the merchant's website.
There are several different kinds of credit cards issued by Visa and MasterCard. The differences between them affect the rates and fees charged for those cards and how a merchant is responsible for processing them.
A consumer credit card is a plain old credit card carried by an average person. It is not tied to a checking account, offer any rewards, or associated with any business. It is not special in any way. These cards are becoming less and less popular as check cards and rewards cards gain in popularity.
A check card is very similar to PIN-based debit cards. Unlike a typical credit card where you wait until you receive your next bill to make payment, and maybe even make a partial payment, the funds for check card transactions are immediately withdrawn from your checking account.
Unlike PIN-based debit cards, however, you do not have to key a PIN number to complete the transaction. You simply sign your name as if you had used a credit card. Also, unlike PIN-based debit, no special equipment is required to accept check cards. The same equipment used to accept credit cards can also accept check cards.
A rewards card offers its cardholder special bonuses for using that card to make purchases. The bonuses will vary by card issuing bank. Typical rewards include airline miles and vacation packages.
All rewards cards are placed into a special Interchange table and typically cost more to accept then a traditional consumer credit card. They typically fall into a mid-qualified rate for retail businesses. Mobile, MOTO, and Internet businesses typically pay their qualified rate for these cards.
Business cards, also called corporate cards, are carried by business owners. These are typically used to make purchases for the cardholder's business. They are popular amongst businesses as they offer extra features not traditionally found in consumer credit cards. The more detailed statements are their primary benefit.
Business cards are placed into a special Interchange table and typically cost more to accept then a traditional consumer credit card. They typically fall into a mid-qualified rate for retail businesses. Mobile, MOTO, and Internet businesses typically pay their qualified rate for these cards.
Purchasing cards are virtually identical to business cards with one exception: they can only be used in predetermined businesses. All transactions outside of the predetermined businesses will be declined automatically.
The predetermined businesses are determined by SIC code. If a corporation has allowed a purchasing card to make purchases from a merchant listed in that SIC code the transaction will proceed normally. The company that the purchasing card has been issued to has the ability to determine what SIC codes a card may be used with. If a merchant has a customer that cannot make a purchase due to the SIC code restriction the customer will need to contact the card issuing bank to have the merchants SIC code added to their acceptable SIC code list.
Although processing a sale is the mostly completed and discussed transaction type it is certainly not the only one. Different transactions will affect the merchant account and fees.
This transaction is just a basic, common everyday sale. Whenever a purchase is made it really is a transparent two-step process. The merchant's POS system contacts the processing bank and acquires an authorization for that credit card transaction. It also requests for that sale to be captured (completed and funds delivered to the merchant).
A refund is very similar to a sale except the flow of funds is the reverse of Authorize and Capture. A refund gives the money back to a customer's credit card.
“Auth Only” transactions are similar to Authorize & Capture transactions except the transaction is not captured. The merchant is issued a six digit authorization number indicating that the funds are available and the transaction is approved. However, the merchant will receive the funds only after they are captured.
Authorizations are only valid for up to 30 days from when the date the authorization is issued and only up to the dollar amount they were authorized for.
An Important thing to note is that the funds from authorizations are frozen on a customer's credit card and cannot be accessed by that customer. From the customer's point of view, that money is essentially spent. Authorizations should not be used without a customer's consent and with care.
Authorizations are captured when a Force transaction is processed.
A Force transaction takes an existing authorization number obtained from an Auth Only transaction and forces the sale through so the merchant may receive those funds. Unused funds from an authorization are immediately freed for the customer to use.
A void transaction erases another transaction of any type. It essentially makes that transaction act and appears as if it never existed.
Voids can only be performed before a POS device has successfully batched its transactions. Once a transaction has been batched a void cannot be performed.
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)
Merchant Service Provider / Independent Sales Organization
It's this fee that makes establishing merchant accounts so lucrative. Although the fee each entity above receives is relatively small, when you have millions of cardholders making purchases at millions of business the numbers add up very quickly. So who pays these fees? The merchant. Why? Because they cannot afford 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:
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.
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 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 Merchant 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.
A transaction fee is a flat fee charged each time a successful transaction is processed. This means the transaction fee is not charged if a transaction is declined. Only an approved transaction will incur this 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.
One of the complexities in accepting credit cards is when a transaction does not qualify for the Qualified Rate. The rates and fees you pay can vary depending on not only the situation under which the transaction occurred, but the type of credit card plays a role as well. Some transactions, possibly through no fault of your own, may incur higher fees for various reasons. Why this happens can vary from provider-to-provider so we cannot provide you with a complete explanation. But you should learn enough below to ask the right questions and intelligently review and acquire a merchant account.
As we saw earlier, there are many different kinds of credit cards available to consumers to make purchases with. Some of these credit cards are considered special by Visa and MasterCard and incur higher, and even sometimes, lower fees. Typically the reason for this is the credit card offers extra benefits to its users and thus carry a higher cost to operate. Someone has to pay for these extra costs and it is the merchants through higher fees.
How these credit card affect a merchant's fees will vary from provider to provider but it can happen in one of two ways:
A surcharge is applied to the purchase
The most common, and oldest, way to handle special credit cards is to apply a mid-qualified or non-qualified surcharge to special credit cards. Even if a merchant does everything that normally would allow a transaction to be charged a qualified rate, the special credit card automatically is charged a surcharge anyway to cover its extra costs.
The credit card has its own special rates
A newer way of handling special credit cards is to create special rates just for them. So instead of the merchant having a regular qualified rate only, they will know have a qualified rate and a rewards card rate. The rewards card rate will be different from their surcharges and only apply when they actually accept a rewards card.
Besides the fees incurred directly for processing credit cards there are other fees associated with establishing and running a merchant account. These fees occur on a regularly scheduled basis and may be indirectly related to the merchant's processing levels.
The statement fee covers the cost for creating a statement for the merchant each month that details the processing history for the previous month as well as a breakdown of the fees incurred from that month's processing. It also typically includes the costs for customer service and technical support as well. However, some merchant account providers will separate their monthly fees for statements and customer service and tech support.
Most providers will not waive this fee even if you decline a paper statement being mailed to your business. This is because they still aggregate that data even if you don't elect to receive it. Plus it also includes your customer service and tech support costs for the month.
The monthly minimum fee is a fee which guarantees the merchant will be paying a minimum amount each month in processing fees. If a merchant's discount fees do not equal their monthly minimum fee they will be charged the difference between the two in addition to their discount fees.
A merchant has a discount rate of 2.50%, a monthly minimum of $25, and a monthly volume of $600. The discount fees for the month will be $15.00 (.025 x $600). Because their discount fees are less than their minimum fee ($15.00 < $25.00) they will be charged an additional $10.00 as a monthly minimum fee ($25.00 - $15.00).
So, what is the purpose of this fee? Merchant account providers and their sales agents make their money by taking a very small percentage of every sale a merchant processes. Naturally this can be very lucrative. But, if a merchant is very small, they won't make very much money from them. So, to make up for this, they charge this monthly minimum fee. Then, when the merchant has a slow month, this fee is incurred and the merchant account provider still makes their profit from this merchant.
This fee is not required by Visa and MasterCard to have an account with them. Many processing companies offer merchant account with excellent rates without the monthly minimum fee.
Annual fees are exactly what their name implies. They are charged each year that the merchant has their merchant account through their current provider. Some merchant account providers charge this fee on the anniversary that the merchant account was established while others charge this fee on a set date each year. There are several different types of annual fee including membership fee and merchant club fees. Regardless of the name they all serve the same purpose.
This is not a standard or common fee for establishing a merchant account.
There are many potential fees that may be incurred while accepting credit cards as payment. The fees listed below are some of the few remaining fees worth mentioning. This is not all encompassing but should cover the majority of fees.
Occasionally a merchant may be instructed by their credit card terminal to call for a voice authorization. All merchants are provided with a voice authorization phone number when their merchant account is established. If they call this number and receive an authorization or decline they will be billed a voice authorization fee.
With computerized systems being more advanced than they were twenty years ago voice authorizations are less common then they used to be. However, they are still common for
This fee is only charged when a transaction processed through your merchant account is disputed. This is always a fixed fee usually in the $15 - $35 range. It is charged for each chargeback and is incurred regardless of whether the chargeback is successful or not.
This fee is incurred each time your credit card terminal or payment gateway settle the transactions stored since the last time a settlement occurs. This fee is charged for each batch that is settled. Typically a merchant settles their sales once per day but occasionally a merchant may have a reason to settle their sales more frequently (their credit card terminal's memory may be full). Each batch settled will incur this fee. The number of transactions do not affect this fee. The same amount is charged whether one transaction is settled or one thousand. This fee is not incurred if there are no transactions that need to be settled.
Most merchant account providers charge a higher fee for batches. Some merchant account providers simply consider a batch just another transaction and only charge a transaction fee which is no different than running a regular transaction (no percentage is charged, just a flat transaction fee).
Some merchant account providers charge a fee when a merchant submits an application for a merchant account. This fee is designed to cover the merchant account provider's costs for processing the application and submitting it to their processing bank for approval. Since merchant account providers do not make any money from a merchant account until after the account is established they may charge this fee to make sure if the application is declined they did not lose any money attempting to establish the merchant account.
This is not a standard or common fee for establishing a merchant account.
Address Verification (AVS) is required on all non-swiped credit card transactions. Failure to do so will cause a transaction to incur a surcharge thus doing so is important whenever a transaction cannot be swiped through a credit card terminal (which is every transaction for all non retail merchants).
Most merchant account providers include AVS for free with all non-swiped transaction but not all do so. Some will list this as a separate fee in order to make their costs appear to be lower. Be sure to calculate the cost of AVS into all non-swiped transaction. Non-retail merchants should add their AVS fee to their transaction fee to get an accurate understanding of their real costs.
This fee is very similar to the Application Fee except it is not incurred unless a merchant account is established. Only at that point is this fee incurred. Merchants whose applications are declined do not incur any fees (unless an application fee is also charged).
This is not a standard or common fee for establishing a merchant account.
This fee is charged to cover the costs of labor when reprogramming an existing credit card terminal or computer software.
This is not a standard or common fee for establishing a merchant account.
Just as the name implies this fee is charged when a merchant account is terminated. Since most merchant account providers do not charge an application fee or setup fee they incur a loss for every merchant account they establish until the merchant processes enough sales volume to make their account profitable. To ensure that each merchant is profitable most merchant account contracts contain a clause that imposes a penalty if the merchant leaves before the contract expires.
Some contracts are open-ended and do not have a cancellation fee. These contracts allow
Interchange plus pricing is a credit card processing pricing structure that details actual transaction processing costs as listed on the Visa, MasterCard, Discover and American Express websites
There is no complicated formula. Here's an example of a qualified rate being applied to a transaction:
Transaction Dollar Amount:
Interchange Plus Fee:
Calculated Transaction Fee:
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 and qualified rate of 1.69% + 25¢ would pay 84¢ for that transaction.
But what if their sale was for $65?
Transaction dollar amount: $65.00 Qualified rate: 1.69% + 25¢
(First calculate the percentage) $65 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 than 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 than $35 their overall costs would be smaller as well.
A blended rate is nothing more than a fee, either percentage based or a flat rate, which 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.
So what happens if your transactions do not qualify for the qualified rate? Most commonly they are charged a Non-Qualified surcharge. This is the highest rate you can pay for a Visa and MasterCard transaction. Basically, by not performing the actions required to make the transaction "qualify" you are increasing the potential risk and exposure for loss the processing bank and Visa and MasterCard may experience. By increasing their potential for loss and increasing their costs they essentially charge you extra to pay for it.
Some possible reasons a sale may be charged at a Non-Qualified rate include:
A credit card was not swiped through a magnetic stripe reader and AVS was not performed properly. Not supplying a zip code or street address will cause AVS to fail.
Not supplying all required fields for a corporate/business credit card. This may include the tax amount for the sale or an invoice number.
Delaying your batches until after 48 hours after a transaction is processed.
Acquiring an authorization and then performing a Force transaction to capture the sale.
If you see a lot of non-qualified transactions on your processing statements this usually is an indication that someone is making errors while processing your transactions. You should call the customer service department of your merchant account provider to find out why your transactions are being charged this fee and find how to correct it.
Unfortunately not all credit card sales qualify for the lowest rate possible. At the same time, they do not deserve to have the highest surcharges applied to them as it really is not the merchant's fault they did not qualify. For these exceptions a "middle ground" surcharge is applied. The cost of this surcharge is usually around half of the Non-Qualified surcharge.
Some possible reasons a sale may be charged at a Partially Qualified rate include:
A credit card was not swiped through a magnetic stripe reader but AVS was performed properly.
A special credit card was processed that cannot qualify for a qualified rate. (See the section "Special Credit Cards" below).
In general this surcharge is only available to card present/retail merchants as all other business types are essentially being charged this fee as their Qualified Rate already.
Establishing a merchant account can be anywhere from a smooth and easy process to a nightmare. Where it falls is both the product of the merchant account provider and the merchant themselves. The better the communication between the two the smoother and faster the process is.
All merchant account providers require that every business sign a contract when establishing their merchant account. At the very least this contract will specify what the merchant's responsibilities are as well as those of the merchant account provider. This ensures that the merchant account provider has as much protection as they can from loss due to risk and other factors. (See "Security and Risk" below to see why this is the case).
Another important factor specified in some contracts is the length of term of the contract. Some contracts require the merchant honor their contract for a set period of time. Failure to complete the contract will result in a penalty being assessed also known as a cancellation fee.
When applying for a merchant account most small and medium-sized merchants will notice that a personal guarantee is required to establish the merchant account. A personal guarantee basically says that if the business cannot fulfill its obligations to the processing bank then the processing bank can legally pursue the guarantor to fulfill those obligations. This basically means if your business owes the processor money and it does not or cannot pay then the bank can come after the guarantor seeking those funds.
The reason why the processing bank does this is because of the high risk they are exposed to due to the nature of their business. If a new merchant commits fraud or just mismanagements their business and merchant account, the processing bank can be on the hook for a large sum of money. Naturally they wish to protect them from this scenario as
Risk is the single largest factor influencing the establishment and maintenance of a merchant account. As with anything financial, someone stands to lose a lot of money if something goes wrong, whether intentional or not. In the world of credit card processing the ones with the most to lose is the acquiring/processing bank. As a result, they make all of the decisions about whether or not a merchant account is established, under what conditions, and whether that account continues to process normally or have their account closed.
The biggest buzz word in the world of merchant accounts is "chargeback". A chargeback is when a customer initiates a refund for a purchase they made on a credit card by contacting their card-issuing bank. The reasons for this can vary greatly but generally is a result of a customer being dissatisfied with their purchase. The customer may or may not have contacted the merchant about remedying this situation ahead of time. They may even be completely wrong. However, responsibility falls on to the merchant to ensure that the transaction goes smoothly and the customer is satisfied. A failure somewhere along the fulfillment process, including at the customer service level, can lead to a chargeback.
When a merchant receives too many chargebacks, approximately 1% of their sales, they risk having their merchant account shut down and losing the ability to accept credit cards again (see "The Match File" below).
One way a processing bank may protect themselves from the risk a merchant account exposes them to be to hold some of that merchants funds in a special account called a reserve. A reserve allows a processing bank to cover potential future costs they may have associated with the merchant including chargebacks and potential fraud. If the merchant is unable to cover the costs of future chargebacks, possibly because they already have gone out of business, the processing bank can access the funds held in reserve to cover those chargebacks. If they didn't have the funds held in reserve they would have to pay those chargebacks out of their own funds.
The amount of the reserve can vary from a small fixed amount to a large fixed amount or an entire month's worth of credit card processing. How the amount held in reserve is determined is based on the amount of exposure the processing bank faces from a particular account. This can only be determined at the time the merchant applies for the merchant account.
Reserves can be created and work in several ways. Sometimes a processing bank will hold all of the funds owed to a merchant until they reach the predetermined amount of the merchant's reserve. Sometimes the processing bank will hold one month's worth of processing and return it after the following month has passed. This is called a rolling reserve. With the exception of rolling reserves funds held in reserve are not available to be returned to the merchant until the potential for chargebacks for their account has passed. Since
Some businesses by their very nature have higher than normal chargeback rates. Sometimes this is due to the product or service offered by the merchant being in high demand but also being high priced (e.g. high end electronic, jewelry, etc.). Sometimes it is because the service causes customers to be misled whether intentionally or not. Regardless of the root cause these businesses will usually find it difficult, if not impossible, to establish a merchant account.
The businesses considered to be high risk will vary from merchant account provider to provider. However, there are some businesses and industries that are consistently considered high risk. This list includes:
Adult Book Stores
Adult Video Stores
Check Cashing Services
Credit Repair Services
Exotic Dancing Establishments
Pharmacies (Card Not Present/Internet)
Sexual Encounter Firms
For these businesses to accept credit cards they typically have to turn to high risk merchant account providers. These companies are typically offshore and always charge higher rates than traditional merchant account providers. Rates can go as high as 20% of sales and some may charge set up fees of $1,000 or higher. The reason why these rates and fees are so high is the high risk merchant account provider needs to make sure they make enough money to cover the costs of the high number of chargebacks they will receive.
The Match File is a database file used by MasterCard and Visa processing banks to identify specific merchants and owners who have had their merchant accounts terminated. Once a merchant is on this list it is highly unlikely that future merchant account applications will be approved. The Match File is essentially a BLACKLIST from which it is almost impossible to be removed.
For a business or merchant to be added to the Match File they need to violate Visa and MasterCard rules in some way. The most common reasons include:
Factoring (ringing sales for another business)
An excessive number of chargebacks
The processing bank concludes that serious violations of the merchant agreement could result in increased loss exposure to itself or the credit card community.
Once a merchant has been placed on The Match File only the processing bank that added them can remove them from it. The merchant must work with them directly to accomplish this.
You do not want to be on the Match File!
Naturally an important aspect of accepting credit cards is how fast you get your money from your credit card sales. Merchant account providers typically provide funds within two business days of when a batch is settled. This means if you process a sale on a Monday and settle your terminal that night, you will receive your funds that Wednesday. Weekends and Holidays do not count as business days so if a batch is settled on a Thursday night the funds from those transactions will not be available to the merchant until the following Monday.
It is possible to have your funds deposited into your business account with 24 hours of settling a batch. For this to occur the process bank must have a direct relationship with the bank you have your checking account through.
An example of this is merchants who have a merchant account through Nova Information Systems and a checking account through Regions Bank will receive their funds in one business day due to the direct relationship that Regions Bank has with Nova.
An overlooked but important feature to note when selecting a merchant account provider is how your funds are deposited and your fees are subtracted. Ideally when you receive your funds you will receive the full amount of the deposit without any fees due being taken out. The advantage to this is it allows bookkeeping to be greatly simplified. If you have a batch of $500 settled on Monday, you can expect to see a deposit of $500 on Wednesday. No need to guess what fees were taken and if there are any problems you can spot them quickly. The fees for your transactions will be deducted at the beginning of the following month at one time. Shortly thereafter you will receive a statement that will detail your transactions and subsequent fees.
Visa and MasterCard do not allow their services to be used for personal reasons. All accounts must be established for one business and to be used only for that business' products and services. An account cannot be established for an individual nor can a merchant use their merchant account for personal reasons.
Visa and MasterCard do not allow more than one business to use a merchant account. All accounts must be established for one business and to be used only for that business' products and services. When a business processes transactions for another business, even if they own that business, they are “factoring”.
Set a Purchase Minimum
Visa and MasterCard do not allow merchants to set a minimum purchase amount for which credit cards may be used. For example, a merchant may not declare that a purchase must be at least $50 in size in order to use a credit card for payment.
The most frequently asked question we get is “what is your rate?” The answer is not as simple as it may seem.
Every time a credit or debit card is swiped there are fees charged by three different entities:
Credit card issuers (mostly banks) charge a fee each time a merchant accepts one of their cards for payment. The term “Interchange” can be simply interpreted as the cost an issuing bank charges when a merchant accepts one of the cards they’ve issued. All Interchange fees are paid to the issuing bank, and not shared with the major Card Associations (Visa, MasterCard, Discover), nor are they shared with the ISO/sales office servicing the account. Interchange fees will generally cost a merchant a percentage plus a flat transaction fee.
Each type of card carries a different Interchange cost. An easy way to explain why different cards carry different interchange costs is through RISK & REWARD.
A merchant can process the same exact credit card two different ways and the Interchange cost will be different. Here is an example:
A swiped Visa CPS Retail card has an Interchange cost of 1.54% + $0.10. CPS retail is a regular credit card that does not earn rewards points.
The same exact Visa CPS Retail Card will cost 1.80% + $0.10 when it is Key Entered (manual) rather than swiped.
The reason for the difference in cost is how the transaction is captured (swiped vs. manual entry).
Years of data and research have shown Key Entered transactions are more often fraudulent or stolen, resulting in a higher rate of charge backs than swiped transactions. Merchants pay a higher fee to accept a keyed transaction because there is a higher risk the issuing bank will take a loss on a fraudulent transaction.
Banks issue credit cards which earn points every time a cardholder makes a purchase. An example of a rewards card is a major airline sponsored card where the card holder earns one air mile for each dollar spent on that card. Once the customer accrues enough miles they are rewarded with a free flight to the destination of their choice. This is a win-win for the card issuer and for the card holder. The card issuer is encouraging their cardholders to make purchases on a credit card rather than spending cash. The cardholder earns “free stuff” for paying for their day to day goods and services on a credit card rather than using cash.
For example, a Visa Rewards card carries an Interchange cost of 1.95% + $0.10. The only difference between a rewards card and a CPS Retail card (1.54% + $0.10) is simply the rewards. In other words, the merchant is paying for those airline miles or rewards points the cardholder is accruing.
Business cards cost the most (starting at 2.05% + $0.10) because there is a mix of risk and reward. There is inherent risk in issuing a card to a business because of the high rate of failure and bankruptcy. Most issuers offer high rewards on business or corporate cards because businesses generally charge more on their cards than a consumer, and issuers want to earn this kind of business.
CARD ASSOCIATION FEES
Each Card Association (Visa, MasterCard, and Discover) charge fees in order operate their networks. Some of the operating costs include infrastructure (the lines and switches required to route each transaction between acquiring and issuing banks), research and development to prevent fraud, setting the rules and guidelines of acceptance, and marketing to promote the card brand.
Interchange Fees, Dues and Assessments, NABU and APF, etc. are known as Processor Fees. These fees are charged to the MSP/ISO by the Card Associations, and in turn passed through to the client.
UNDERSTANDING THE RATE STRUCTURES
There are two rate structures commonly offered to merchants:
Interchange Plus Pricing
Tiered (Bucket) Pricing
INTERCHANGE PLUS PRICING
In addition to the wholesale costs (Interchange, Dues and Assessments, NABU and APF),
In the following example we are marking up the wholesale rate 0.20% and $0.10 per transaction.
We pass through interchange and add 0.20% plus $0.10 regardless of the wholesale cost.
*The 0.20% markup is commonly referred to as the Discount Fee
If a merchant accepts a Visa Rewards card, they will pay:
+0.20% + $0.10 Discount fee + Transaction fee
The same formula would be used if the merchant key entered a CPS retail card. The only difference would be substituting the 1.80% + $0.10 interchange fee associated with a key entered CPS card. After adding Interchange, the Discount fee of 0.20% and the transaction fee of $0.10 the total fee paid by the merchant would be 2.00% + $0.20.
The variable in this pricing structure is the Interchange Fee. It will change according to the type of card the merchant accepts. The discount fee and the authorization fee will remain constant when calculating the cost of accepting each type of card.
From the explanation of wholesale above, we already know there are many Interchange categories/rates. On the Interchange
This rate structure drops hundreds of Interchange categories into one of the four tiers listed below.
Also included is an example of the average rates we are seeing on our competitor’s statements:
CHECKCARD RATE* 1.60% + $0.25 (Includes any card linked to a checking account)
QUALIFIED RATE 1.75% + $0.25 (Includes non-rewards credit cards)
MID>QUALIFIED RATE 2.89% + $0.25 (Includes all rewards cards and keyed transactions)
NON>QUALIFIED RATE 3.75% + $0.25 (Includes all business cards and foreign bank cards)
*3-tier rate structures combine the Checkcard and Qualified tiers under a single qualified rate
Again, we’ve noted above that the cost of wholesale is the same to the processor regardless of what rate structure the merchant has. Interchange cannot be impacted by the MSP/ISO.
The two most common wholesale Interchange categories that fall into the Checkcard rate are Visa
CPS Retail Debit and MasterCard Merit III.
The Qualified rate is a teaser rate. Most consumer cards used in the United States are either Checkcards or Rewards cards. There are not many card holders carrying non-rewards credit cards. The Interchange rates for cards that fall into Visa CPS Retail and MasterCard Merit III.
Many Processors pitch 1.69% to new merchants. They do not mention anything about any other rates or fees, so the merchant thinks they are going to get 1.69% on all transactions. Their account rep or Merchant Service Provider is not disclosing there are Mid-Qualified and non-qualified rates or surcharges.
The Mid-Qualified rate includes transactions swiped rewards cards and Key-entered transactions carrying an Interchange cost between 1.80% + $0.10 and 2.05% + $0.10.
A Mid-Qualified rate of 2.50% + $0.25 remains constant whether the merchant accepts a card with an Interchange cost of 1.65% + $0.10 or a card with an Interchange cost of 2.05% + $0.10.
A merchant paying 2.50% on a Visa Rewards card with a cost of 1.65% is paying a markup of
The same merchant paying 2.50% on a Key-Entered MasterCard Enhanced card with an Interchange cost of 2.05% is paying a markup of 0.45%.
The markup of 0.85% is not a good deal for the merchant. The markup of 0.45% is fair. This means the merchant is paying between 0.45% and 0.85% on cards in this category.
The Interchange rates in the Non-Qualified category will range from 2.10% to 3.25%, with most cards falling between 2.20% and 2.65%.
At a Non-Qualified rate of 3.50%, the merchant is paying a markup between 0.25% and 1.40%.
The reason an interchange pass through pricing structure is better for the merchant is because the markup is low and fixed regardless of the type of card they swipe. On a tiered rate structure, the markup varies, and always costs more.
In July 2011, the Federal Reserve was required by Congress to rule on a reduced Interchange fee banks are allowed to charge when a merchant accepts one of their debit cards. Prior to October 1, 2011 the average Interchange cost banks were charging was $0.44 per transaction. The Federal Reserve ruled that the banks can only charge 0.05% + $0.22 per transaction. This brings the average down to $0.24 per transaction. This is nearly a 50% reduction in the average fee.
HOW THIS NEW RULE AFFECTS SMALL & MEDIUM-SIZED MERCHANTS:
Merchants processing on an Interchange Plus rate structure will automatically see a reduction in their fees associated with debit cards.
Businesses on a tiered pricing structure will not automatically receive this price reduction. The wholesale cost incurred by the processor goes down does not mean they will automatically lower the fees being assessed
In order to benefit from this government mandated fee reduction the merchant MUST be on an Interchange plus Pricing structure. This creates a HUGE selling point vs. Tiered processors.
The previous pages are not intended to be an all-inclusive compendium of merchant services. It is intended to give you a solid foundation, a starting point. If you have gone through the material you now know more terminology than the average person.