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Credit Card Processing Downgrades

You may have heard the term "downgrade" used before when speaking with merchant services companies in the past. It was more than likely said without any meaningful explanation as to what a transaction downgrade is, and how it effects your bottom-line.

By understanding what credit card processing downgrades are and how to avoid them, your business will better position itself to pay as little as possible in credit card processing fees each month.

The good news is that these downgrades are an avoidable expense. The bad news is that it requires an expertise to recognize and correct these downgrades, and payment processors have no fianancial incentive to do so. Which has left business owners with the burden of trying to detect and address these downgrades on their own.

In this blog post, we will explain what credit card transaction downgrades are, how to identify them, and how to correct them.

What Is A Transaction Downgrade?

Each time you process a credit or debit card payment, it is assigned to an interchange category. That category has a corresponding interchange rate that payment processors use to calculate the cost of the transaction. Every transaction has a target interchange category, which is the category that offers the lowest rate and fee for the given transaction type.

A downgrade occurs when a transaction is routed to an interchange category that carries a higher rate than the target category. When this happens the transaction is said to have “downgraded.”

For example, a Visa Rewards 2 transaction has an interchange rate of 1.95%. But if that transaction is not settled within 24 hours, it will downgrade to an interchange category called EIRF. The interchange rate associated with EIRF is 2.30%. So in this example, the downgrade increased the cost of the transaction by 0.35%.

Now that rate increase may seem like a minor thing at first glance, but when you calculate in these rate increases over the course of an entire month, they will many times cause a business to overpay in their processing fees by hundreds of dollars, if not thousands of dollars, each month.

Why Do Downgrades Occur?

While some transaction downgrades can be attributed to faulty POS equipment or POS software that needs updating, the vast majority of downgrades are a result of a business’s processing behaviors – meaning how it authorizes and settles credit card transactions.

The bad news is that businesses are often the cause of their own downgrades. But the good news is that this provides the opportunity to adjust these behaviors to eliminate, or at least significantly reduce these downgrades.

Transactions Most Vulnerable to Downgrades

Visa, MasterCard, and Discover all have interchange qualification guides. These guidelines outline the requirements a transaction must meet for various interchange categories. Transactions that don’t meet these requirements will downgrade to an interchange category with a higher rate.

Retail businesses that swipe or "dip" cards through a credit card terminal are much less susceptible to downgrades than businesses that do not swipe cards, such B2B or e-commerce companies.

The reason being, when a transaction is swiped or "dipped", the POS equipment electronically reads and transmits all required data to the processing network. The technical term for this process is called “electronic data capture.”

This isn’t the case with card-not-present (CNP) transactions such as keyed-in or e-commerce. In these instances, a person must ensure they have provided all the required data. That is much less reliable than having a piece of equipment perform the task automatically.

What Are The Most Common Reasons for Downgrades?

The most common reasons for downgrades differ for card-present and card-not-present transactions. The most common reasons for each are listed below:

Card-Present transactions:

  • Stale Authorizations
    A stale authorization is one that has surpasses the allowable time between authorization and settlement. Authorizations must be settled in order for a business to receive money from a transaction. If too much time passes, the transaction is said to be stale, and it will downgrade. Most interchange categories require an authorization to be settled within 24 hours.

Card-Not-Present transactions:

  • Stale Authorizations
    The same explanation as noted above.
  • Not Using AVS
    AVS stands for address verification system, which is a fraud deterrent tool that tells businesses whether the address provided by a cardholder matches the address on file at the cardholder’s issuing bank. The customers 5-digit Zip Code is required for card-not-present transactions to qualify for their target interchange rate. If a customer’s zip code is not provided, the transaction will downgrade.
  • Not Providing A Customer Code
    This reason applies to business and commercial credit cards. Commercial cards have unique interchange requirements, and one such requirement is that a customer code be provided with the transaction. A customer code is any numeric value. To avoid these downgrades, supply a customer code when processing these types of transactions. If you don’t have or know the customer code, provide any numeric value to satisfy the interchange requirement.

How Much Do Downgrades Impact My Cost?

Downgrades cause a transaction to be processed at a higher rate, which results in a higher processing cost for your business. Exactly how much higher the cost will be depends on a few variables, the most important of which is the pricing model that your merchant account setup on. The three most common pricing models are Tiered Pricing, Bill-Back Pricing, and Cost-Plus Pricing.

Tiered Pricing & Downgrades

When a merchant account is setup to use the Tiered Pricing model, a payment processor will assess fees to a business by funneling interchange costs through its own contrived discount rates. In addition to its numerous other negative aspects, tiered pricing can actually allow your processor to profit from your transaction downgrades.

Payment processors typically make a much larger profit margin on the Non-Qualified rates used in Tiered pricing, and interchange categories associated with downgrades are routed to the Non-Qualified pricing tier.

Not only will this substantially increase a business’s processing costs, it completely disincentives a processor from helping a business to identify and correct these downgrades, because that would decrease their profit margin on that account.

How To Recognize Downgrades?

Take a close look at your most recent credit card processing statement, and see if any of the following downgrade terms are listed on it.

  • Qualified or Qual
  • Mid-Qualified or MQual
  • Non-Qualified or NQual
  • Standard or STND
  • Electronic or ELEC
  • Level 1
  • EIRF
  • Data Rate 1 or DR1
  • CNP
  • Bill-Back - example: MAR BB196 Transaction Cleared As...

If the answer is YES, this indicates that your merchant account is setup incorrectly, and your business is overpaying for credit card processing.

Correcting Downgrades

The very best course of action is to switch to a payment processor that does not use Tiered Pricing or Bill-Back Pricing models.

At Tailored Transactions, we setup all of our merchant accounts using the pricing model known as Cost-Plus Pricing aka Interchange Plus Pricing. It works by passing through all of your credit and debit card transactions at their respective interchange rates, and then a small fixed markup is applied on top.

Being setup on this pricing model will help to eliminate most downgrades, however, it still takes some expert tweaking and "fine-tuning" of your POS equipment or payment gateway to ensure that these downgrades become a thing of the past. We work closely with our clients to ensure that their point-of-sale setup is optimal. We also closely monitor our clients monthly statements in order to detect and immediately address any downgrades that may have occurred during the month.

If you send us a copy of your recent credit card processing statement to review, we will send you back a detailed rate quote showing how much money your business can save in processing fees each month. Our rate quote will detail any and all downgrades that you have been incurring, and how we will resolve them.

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