Level 2 and Level 3 Payment Processing: A Simple Guide to Lowering Interchange Fees

The digital payment environment is increasingly complex. Today, merchants and service providers must accommodate a growing number of payment methods and platforms, as well as navigate PCI DSS compliance amid the fraud risks that come with them.

There’s also a complicated “cost of doing business” – made up of interchange fees, assessment fees, and processor markup. According to NerdWallet, they can add up to 1.5-3.5% of a transaction’s value. Overwhelmingly, 70-90% of that comes from interchange fees. Today we’re breaking them down to help merchants uncover any potential savings opportunities.

What are interchange fees?

Let’s start with a quick definition. An interchange fee is what a merchant’s bank pays to a customer’s card-issuing bank each time a credit or debit card transaction is processed. It essentially serves as compensation for the issuing bank for the risk and cost of providing credit to the cardholder. These costs are passed through to merchants by their banks as part of their overall processing costs.

This fee is not a specific dollar amount, but rather a percentage of the total value of the transaction. That percentage varies by processing level. Each transaction is processed at one of three levels.

Level 1 processing

Level 1 processing applies to most business-to-consumer (B2C) transactions, using personal credit cards – think retail store and restaurant purchases. This level requires businesses to share only a few basic details when processing the card. It has the highest interchange fees. 

Level 2 processing

Level 2 processing applies to business-to-business (B2B) and business-to-government (B2G) transactions. This level requires more data to be collected, lowering the risk that the issuing bank is taking on, like costly chargebacks. Due to this, the interchange rate is reduced by up to .5% when compared to Level 1.

Level 3 processing

Level 3 processing applies to the higher value and volume of transactions by large B2B and B2G companies. Level 3 processing has much more complicated data requirements (more on that later), but it offers the deepest interchange discounts – often 1% below Level 1 rates.

What do these interchange fees look like on paper? Let’s take a B2B manufacturing company processing $2 million annually, as an example. Here are the annual cost estimates at each processing level: 

• Level 1 (~2.75% interchange rate + $0.30 per transaction): $55,000 + transaction fees
• Level 2 (~2.25% interchange rate + $0.25 per transaction): $45,000 + transaction fees
• Level 3 (~1.85% interchange rate + $0.20 per transaction): $37,000 + transaction fees

Qualifying for Level 2 and 3 payment processing

On paper, it would appear that all merchants and services providers should try to benefit from the cost savings of Level 2 or 3 payment processing. However, businesses must meet certain criteria in order to qualify for a higher processing level. The biggest factors include customer base, transaction value, commercial card percentage of transactions, and system capabilities for data capture.

Qualification Assessment Chart

Criteria	Level 1	Level 2	Level 3
Customer Base	Pure B2C	Mixed B2B/B2C	B2B/B2G
Transaction Value	~$25-$75	~$75-$250	~$250+
Commercial Card %	Less than 20%	20-60%	60% or more
System Capability	Manual	Semi-automated	Fully automated

A deeper dive on the critical element of data capture

Even qualifying businesses can struggle to meet Level 3 data capture requirements. Doing so effectively depends on how advanced their ERP system is and whether they’re actually using all of its features and functionality. Companies without fully automated processes will need to invest additional time, money, and training to capture the detailed transaction data that Level 3 processing requires. 

It’s important to consider these costs when determining if the ROI is high enough to outweigh the operational and technical costs. That’s why many businesses choose to start with Level 2 processing, given the significant lift required for Level 3.

Data Requirements by Payment Processing Level

Data Field	Level 1	Level 2	Level 3	ERP Source
Card Number	✅	✅	✅	Payment processing
Expiration Date	✅	✅	✅	Payment processing
Transaction Amount	✅	✅	✅	Order total
Merchant ID	✅	✅	✅	Payment gateway
Tax Amount	❌	✅	✅	Tax calculation module
Customer Postal Code	❌	✅	✅	Customer master file
Purchase Order #	❌	✅	✅	Order management
Line Item Details	❌	❌	✅	Product catalog/inventory
Product Codes/SKUs	❌	❌	✅	Item master file
Unit of Measure	❌	❌	✅	Inventory management
Freight/Shipping	❌	❌	✅	Order processing
Discount Amounts	❌	❌	✅	Pricing engine

Considerations for advancing payment processing levels

Advancing to Level 2 or 3 payment processing can bring significant cost savings from reduced interchange fees – if you have the back end systems and processes to support it. But there are additional benefits, too.

• More secure transactions from the additional work in validating customer data
• Streamlined processes through stronger integration with internal procurement and accounting systems
• Ability to meet compliance requirements for government and corporate purchases
• Enhanced dispute resolution from better documentation 
• Improved customer service with more data available to troubleshoot client issues
• More complete data allows for deeper customer and operational insights to make better business decisions

Achieving (and maintaining, without penalty) a higher level of payment processing for your transactions takes work. Here are five next steps when evaluating if moving to level 2 or 3 processing is the right move.

1. Assess card mix. Look at a minimum of three months of transaction data to identify commercial card volume and average ticket sizes.
2. Audit systems. Inventory what Level 2 and 3 data your current systems capture and identify gaps. Consider the cost/benefits of switching to a platform like ARISE that can provide enhanced security features that support Level 2 and 3 processing.
3. Start with Level 2. If you’re not capturing enhanced data yet, implement Level 2 requirements first. This will help you start realizing immediate savings while you further prepare your processes and operations for Level 3 processing.
4. Plan out integration efforts. Work with your payment processor and gateway to map out field requirements and testing procedures.
5. Continuously optimize. Track qualification rates monthly and address any data issues that prevent transactions from qualifying. In 2024 Visa introduced new penalty rates for incomplete data, stricter validation of product category codes, and enhanced fraud monitoring. These changes make data accuracy and security critical.

Level 2 and Level 3 processing often require significant system changes and a whole new approach to ongoing data management. However, it can be worth it, as long as businesses are well informed, prepared, and have clear expectations for ROI.