Ever walked into a shop and reached for your credit card only to think twice because of a surcharge? Or had a merchant block a certain type of card or refuse payment unless you bought a minimum amount?

It all comes down to hidden payments known as “interchange fees”, which shop owners indirectly pay every time we use a credit or debit card. Merchants must choose whether to either absorb those costs or pass them onto the customer.

Understanding just how those behind-the-scenes payments work is an important step to making sure you get the most value when spending your hard-earned dollars.

Surcharging

Back in 2003, the Reserve Bank of Australia (RBA) decided it was time to allow merchants to recoup some of the costs of accepting credit cards by allowing shops to surcharge customers. It made sense – banks were encouraging customers to use their cards by offering lucrative reward scheme points (often at no cost if they paid their balance in full each month), while merchants were picking up the tab.

Today, merchants pay an average service fee to their bank for processing MasterCard and VISA credit cards of 0.78 per cent of each transaction price. A decade ago, it was closer to 1.5 per cent, which is why reward schemes were so much better back then. That drop in merchant fees should have resulted in lower goods and services prices for everyone – not just rewards for credit card holders – at least, that was the RBA’s theory.

American Express and Diners Club cards are slightly different – the RBA doesn’t regulate them in the same way as MasterCard and VISA. They are significantly more expensive to accept which is why many retailers apply a higher surcharge or don’t accept them at all.

An American Express card costs a merchant an average of 1.81 per cent to process, while Diners Club cards cost an average of 2.07 per cent. That’s also why they offer better reward schemes – the merchant is paying for those too.

Is it fair?

Few retailers apply a surcharge to MasterCard and VISA credit cards except those in sectors with minimal competition.

“It’s pretty hard to make a dollar in this day and age,” Australian Retailers’ Association executive director Russell Zimmerman says. “And to put that barrier up with surcharging, then it’s obviously a barrier to the customer. But the only people I think who are really abusing surcharging at the moment are the taxi industries and the airlines.”

Most big utility companies still apply a small surcharge: for example, pay your Telstra bill with a MasterCard, VISA or American Express credit card and it’s an extra one per cent. Choose a Diners Club card and it’s an extra two per cent.

That charge appears to be quite close to the average merchant service fee – however, big companies have more clout with their banks. A company such as Telstra would be paying its bank a significantly lower service fee to accept card payments. However, the surcharge is easy enough to avoid given other fee-free payment methods, such as BPAY, are simple to use.

But as Zimmerman points out, airlines charge several dollars to accept a credit card payment (for each flight – even when they’re booked at the same time) and taxis charge an incredible 10 per cent. Such excessive surcharging was one of the reasons the RBA earlier this year allowed VISA and MasterCard to limit a merchant’s surcharge to “the reasonable cost of acceptance”.

There has been little more than tinkering in the airline industry so far but in May, the Victorian government ordered taxi company Cabcharge to halve its card processing fee to 5 per cent – a move that will save customers millions of dollars.

Cash versus debit cards

Many small shops still prefer cash. In fact, some still enforce a minimum purchase price if you use a debit card or won’t accept them if you buy some items like bus tickets. It doesn’t make a lot of sense.

Customers generally use one of three types of debit cards linked to their bank savings to pay for items: MasterCard debit, VISA debit and EFTPOS. Each attracts their own interchange fees, which form part of the merchant’s overall service fee for accepting such payments.

The benchmark is 12c per transaction but many payments are less. For example, if a customer uses their MasterCard contactless PayPass card the interchange is just 5.5c per transaction. Bigger merchants are also charged less. For example, VISA Debit card interchange fees applied to supermarkets and petrol stations amount to just 6.6c per transaction. The EFTPOS system is the cheapest of all: Purchases under $15 are completely free for merchants to accept.

However, the service fee the merchant pays is higher that the interchange fee (after all, the banks need to make even more money). An ongoing issue is that some merchants pay a “blended” service fee to their bank for every card transaction they accept. It means there is no incentive to accept lower-cost cards.

Nonetheless, the convenience of accepting a card shouldn’t be underestimated – cash is not free either: handling cash, back-office processing and accounting all has a price. An RBA study in 2007 estimated that accepting a $19 cash payment cost a merchant about 25c, rising to between 46c to 76c for a $70 payment.

So maybe the next time a merchant won’t accept a debit card payment – particularly EFTPOS – it’s worth asking why.

Brendan Swift is a journalist who has been writing about superannuation and financial services for a decade.