Why You're Paying More to Spend Your Money

Paying in cash has never been more out of style. But with just about every other way to pay, there's a third party outside the transaction that's taking a cut -- and all those cuts add up to serious profits for the companies involved.

Between credit cards, debit cards, electronic funds transfers, and more recently mobile-payment systems, consumers have more choices in how they choose to pay for things than ever. Each of those payment methods, however, has consequences not just for the buyer and seller but also the companies that provide payment services on both ends of the transaction. In the end, the more money those third-parties get, the more it costs you to buy what you need.

Debit-card fees entered the limelight last year as the Durbin Amendment to the Dodd-Frank financial reform law took effect. The law addressed complaints from merchants that transaction fees for accepting debit cards were too high by imposing caps on the amounts card issuers could charge for transactions.

A recent report from the Federal Reserve shows that the law has succeeded in cutting what Visa (NYS: V) , MasterCard (NYS: MA) , and Discover Financial (NYS: DFS) receive in transaction fees. The report shows that average transaction costs have fallen almost 45% in the past two years, now weighing in at $0.24.

Unfortunately, some small businesses don't appear to be getting the benefit of the reform's impact. As CNNMoney discovered, some stores that sell low-cost items lost some favorable arrangements they had with card companies, essentially bringing them up to the overall average.

But the trend toward letting payment middlemen make huge profits goes beyond plastic. Online auctioneer eBay (NAS: EBAY) owes its renaissance not to its namesake business but to PayPal, which makes money facilitating payments -- first for eBay auctions but then expanding throughout the online retail world.

PayPal works hard to maximize its revenue. Whenever you try to pay for something, PayPal suggests using a bank-account electronic funds transfer, only resorting to credit card transactions if you insist. The reason: PayPal avoids credit card processing fees on bank transfers. Yet on the receiving end, for all but the most basic of accounts, sellers pay the same fee of between 2.2% and 2.9% plus $0.30 per transaction -- fees that largely go straight to PayPal's bottom line for bank transfers, taking money out of sellers' pockets.

In some cases, there are even additional layers of middlemen. Between card companies and merchants, you'll sometimes find payment processors, which aren't required to pass their Durbin Amendment savings on to their customers. As a result, merchants may not see much if any improvement in their net revenue after accounting for payment fees.

The first step that merchants and consumers have to take to stop the trend of higher fees to payment-middlemen is to make the cost clear and up front. The best way to do that is to provide discounts for cash transactions that reflect the true savings versus credit and debit cards.

Discounting cash will retrain customers to move away from other ways to pay. Right now, credit card issuers Bank of America (NYS: BAC) , Citigroup, and JPMorgan Chase are just a few of the banks that have done a great job of giving cardholders massive incentives to use their cards, with significant rewards of cash and other perks from card purchases -- essentially giving you a cut of their cut. If retailers provide similar or even greater rewards for using cash, it'll make many customers think twice before pulling out their plastic. But if they don't, those who pay with cash will end up paying for the higher costs that card companies impose.

Knowing the cost of spending money through various methods is important in order to understand how it affects the companies you do business with, especially smaller ones. With razor-thin margins in retail, the pennies that go to middlemen can mean the difference between success and failure.

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At the time thisarticle was published Fool contributor Dan Caplinger spends way too much time on credit card rewards. He doesn't own shares of the companies mentioned in this article. You can follow him on Twitter here. The Motley Fool owns shares of MasterCard, JPMorgan Chase, Citigroup, and Bank of America. Motley Fool newsletter services have recommended buying shares of eBay and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy won't cost you a thing.

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