Understanding the “The Discount Rate”

Understanding the “The Discount Rate”

In the realm of merchant accounts offered by banks and credit card processors, the discount rate has a special meaning that is important for a small owner to understand. Where the discount rate classically refers to the rate charged by the Federal Reserve to other banks when they borrow, in the credit card world, this is the rate charged on a per transaction basis when an individual sale is processed by credit card. A thorough understanding of this rate and fee is important because it has a direct and immediate impact on a business’s profitability.


The Basic Cost Structure

Typically, when a small business wishes to accept credit card payments, a veritable necessity these days, that company must obtain a merchant account. The bank or credit card processor that offers the merchant account will charge a variety of fees, including a discount rate. This rate refers to the percentage of each transaction’s value that the processor will keep for itself as a fee for its service. This rate is typically between 2 and 4 percent, but may be higher based on various factors. For example, if a business is paying a 2% discount rate and completes a sale for $100, the customer’s credit card will be charged $100 and the company will receive $98 in its merchant account. The remaining $2 is retained by the processor as a fee for the transaction. Particularly in low margin businesses, understanding this fee can have a dramatic effect of a company’s profitability.

The other fees that are involved in initiating a merchant account include an application fee, a fixed fee for maintaining the account and a fixed per transaction fee to which the discount rate is added. All of these fees can become a significant burden on a company, and as such, shopping around for competitive rates and packages is prudent. Finding ways to reduce these costs, or keep them under control, is an important part of being successful. The rates available from one company to another may differ significantly, so checking regularly is wise.


Factors That Affect the Discount Rate

There are many factors that impact the discount rate that a business may obtain from a given merchant account provider. Some of the most common include:

  • The credit of the business
  • The credit of the principal business owners
  • The operating history of the business
  • The business segment in which the business operates
  • The average transaction amount
  • The percentage of sales attributable to credit card transactions
  • The length of the relationship with the merchant account provider
  • The charge-back history of the business

Each of these factors has an impact on the total rate, but the more favorable that each of these represent, the lower the rate. In some cases, the merchant account provider may use a base rate and then add a fraction of a percent for each of the above factors.

Another criterion that can impact the discount rate is the percentage of business that a company does online. Because there tends to be significantly more fraud online than through face-to-face transactions, the discount rate may be higher for companies that see significant online traffic. The providers justify this as a form of insurance for them against fraud, although the higher rate may outpace the protection in some instances. Overall, because this can be such a significant cost to a business, finding a merchant account provider that offers competitive rates and outstanding service is highly important. The time spent to find the right service-provider will be more than covered as one’s business continues to operate.

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