There’s a creeping cost that can become unmanageable if you’re not aware: the cost of your payment processing. To keep payment processing expenses pruned to the minimum, one of the first things that we do is calculate the effective rate. Once we find the effective rate, we can determine what costs may need to be weeded out, and which are necessary for business growth.
What Is An Effective Rate Anyway?
The effective rate is the total processing fees divided by total sales volume on your credit card processing statement. It’s usually expressed in the form of a percentage, and it’s is one of the quickest ways to uncover if you’re paying too much for your merchant account.
Understanding Credit Card Processing Costs
Because your effective rate is the total cost including all markups and other fees that you’ll incur if you swipe, dip, or tap, it’s important to establish a baseline. No matter who your credit card processor is, you’ll encounter one type of cost no matter what: the interchange rate. Interchange rates represent the wholesale credit card processing price of any transaction.
Every single credit or debit card transaction has a specific wholesale cost and it varies depending on how it’s processed in (e.g., eCommerce vs. retail), and the type of card that is used (e.g., basic, rewards, business). So when you look at processing costs, keep in mind that every single transaction has a different wholesale price or interchange rate associated on the back end. It’s true that you might not always see this difference on the front end (e.g. if you have flat-rate pricing), but these costs are constant on the back end of things no matter what.
Your effective rate is a combination of this interchange fee plus your processor’s markup, and any other fees that could balloon your costs.
For a good overview and crash course in terms, check out our Complete Guide To Credit Card Processing Rates And Fees. For now, let’s keep going down the path of finding our effective rate.
How To Find The Effective Rate For Your Processor
To find the effective rate for your credit card processing, you first need to round up all of the fees on your statement and add them up. We’ll use the following statement as an example: In the example above, we’ve highlighted the total sales volume in green, and the total fees in red.
So, what is the effective rate for this statement? If you figured out 5.99 or 6% (rounded) you would be right. To find the effective rate, you divide the total sales by the total fees:
$5907.03 / $98511.45 = .0599 or 5.99%.
So now we know that we are a hair under 6% for our effective rate. But what does this 6% mean in the context of payment processing? Is it too high, or is it just right?
To determine that, we need to figure out how much the merchant should be paying. We need to know if 6% is industry standard, or if it’s much higher.
What Is A Good Effective Rate For Credit Card Processing?
Generally speaking, a good effective rate for credit card processing is around 3-4% — I share that figure to give you a starting range for the “red-flag area.” Now that being said, there also may be some legitimate reasons your rate inches beyond that.
Here are a few things to consider when you look at your effective rate for credit card processing. By going the checklist of questions below, you can identify any potential areas of concern:
- Are you considered high risk? High-risk merchants can be defined by industry, and if you are considered high risk, you should expect to pay higher rates to process their transactions, regardless of what the interchange rates are.
- Can you spot hidden or junk fees? Remember, the effective rate takes into account total fees, not just interchange rates and rate markups. You could have hidden fees or incidental fees for that particular month. Check out our complete guide to rates and fees and our guide to analyzing your processing statement in full to learn more about all the potential fees involved in card processing.
- Is your average transaction size quite small? Businesses with very small average tickets are often hit hard by the flat, per-transaction piece of an interchange rate or processing rate. For instance, if you sell very small-ticket items, the effective rate on a flat-rate plan could be higher than it could be before any other fees are counted.
- Do you have international transactions? Card brands like Visa and Mastercard also charge some wholesale transaction fees, but that these are typically much less than interchange. The exception is for international charges, particularly if currency conversion is involved. If your processor passes cross-border assessments through on the statement, this is added on top of all other normal fees and rates.
- Are your transactions being downgraded? Downgrading means that transactions are getting bumped into higher-rate tiers for any number of reasons (most of which are completely out of your control). If you’re on a tiered pricing plan, we’d check to see costs on qualified vs non-qualified credit card transactions. We generally recommend steering clear of tiered pricing plans because fees often get muddy and unpredictable.
- Are there other factors inching costs up? If you’re on a more transparent cost-plus model (like interchange-plus or subscription) you can also examine your statement in more detail to look at any specific fees like annual fees. You also want to identify if your team is manually keying in transactions, which almost always cost more to process and should be avoided if possible. Additionally, security fees could also contribute to your overall effective rate. And to add to all that, you may identify other rogue fees that may not have been clearly disclosed if you were lulled by a “teaser rate”.
- Is the processor’s markup too high? This one’s pretty self-explanatory, but it’s also worth pointing out that the only way you can accurately see the difference between standardized, wholesale costs (like interchange) vs. the processor’s variable markup is with a cost-plus/pass-through pricing plan like interchange-plus.
How To Find The Best Merchant Services Rates
Now that you have a better idea of what might contribute to your effective rate, the value comes in using this data to find the best rates on credit card processing for your small business. When it comes to looking for the best merchant services rates, you’ll want to find companies that meet the following criteria:
- No early termination fees
- Month-to-month agreements rather than long contracts
- No or small PCI compliance security fees
- Clearly published rates
- No junk fees or bait-and-switch tactics (We look at customer reviews to uncover these.)
The Bottom Line: Break Out Your Merchant Processing Statement & Do The Math For Yourself
By now you’re probably feeling more empowered to take the reigns and make better choices for your small business. To recap, if you’re fuzzy on what you’re paying in payment processing, the first step is to get yourself a fresh statement, add up your total fees and divide those by total sales. Should you find that your effective rate is over 4% for just processing, you might want to start asking some questions which we’ve outlined above.
Not happy with what you found in your statement? Check out some of the best options for credit card processors in our Merchant Account Comparison Chart. These are free of the bigger red flags you’ll want to look out for, and they all have excellent pricing transparency.