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Currency Conversion and Foreign Transaction Fees: How Do They Work?

Stephen Hart

Stephen Hart

Founder - Cardswitcher

Former - Chief Financial Officer @ Worldpay

Either as a business owner or a customer, chances are you have had some unpleasant encounters with payment providers and ATMs that charge fees when foreign currencies are involved. Even in today's world of seamless overseas payment apps, the majority of payment terminals and bank ATMs in the UK and Europe, charge both currency conversion and foreign transaction fees. This encompasses all payments made in currencies that are not the currency of the country the payment is made in.

By some estimates, British holidaymakers lost a staggering £640 million last year on exchange and transaction fees. If you run a customer-facing business, chances are the payment processing services you provide will use these fees. Therefore, it is essential to understand what they are and how they work, so that your customers are not left in the dark. Read this comprehensive guide to currency conversion and foreign transaction fees to find out everything you need to know.


Foreign Transaction Fees Explained

Let's begin with the more straightforward type of fee; foreign transaction fees. If you make a purchase overseas, including online purchases, then most merchants charge a transaction fee that is equivalent to a certain percentage of the overall cost of the purchase, with taxes included.

This same rule often applies to overseas withdrawals from an ATM. The vast majority of foreign transaction fees stand at between 1-3% of the total cost of the purchase/withdrawal, and are found in businesses of every shape and size, large or small.

On the face of it, foreign transaction fees are meant to cover the additional administrative/resource costs of transferring the money from your domestic bank account or credit card. This is either over to the account of the overseas merchant you are making a purchase from, or the withdrawal of money from a foreign ATM.

In reality, these transaction fees are often much higher than any actual costs incurred, especially given that many international cash transfers these days can now be completed for free.


Currency Conversion Fees Explained

Currency conversion fees are often more widespread with physical merchants than online ones, and are often described as the scourge of travellers everywhere. In a nutshell, a currency conversion fee is a charge levied by a payment provider for the conversion of the 'local' currency of wherever you are making the payment, into the currency of your 'home' bank account or credit card.

For example, if you were on holiday in Tokyo and wanted to buy a souvenir that cost 1500 Japanese Yen (around £11.50), you could find out immediately how much it will cost you in pounds from your UK bank account if you are charged a Dynamic Currency Conversion (DCC) fee.

This fee will use the current GBP/JPY exchange rate to calculate exactly how much your purchase will cost in pounds according to international foreign exchange (forex) markets at that moment, and charge that amount to your British bank account.

As you can imagine, this service comes with a hefty fee. By some estimates, the charges levied for an on-the-spot DCC fee with some payment providers can be as high as 12%, although it is usually much lower, at around 1-4%. This means that, if you were charged a top fee for that Japanese souvenir, you would end up paying an extra £1.38 on top of the purchase price.

With most vendors, DCC fees are avoidable and optional, with a sign appearing on the payment terminal asking whether you wish for instant currency conversion. If you are not in a hurry to see exactly how much a purchase is costing you in your home currency, then simply decline this.

It's also worth noting that currency conversion fees and transaction fees may both be charged simultaneously and concurrently on a single purchase. On your receipts and bank statements, these fees will often be rolled into one.

For example, if you see you have been charged 5% in fees on top of the purchase price for something bought abroad, then it is possible that the 5% will be 1% transaction fee, plus 4% conversion fee.


What Affects a Currency's Exchange Rate?

Whether you're a business that deals with customers from overseas, or simply someone planning to make purchases abroad, having a proper understanding of what actually affects exchange rates of different currency pairs is important.

National economies, political events, and trading activity all affect currency exchange rates on a minute-by-minute basis, with a single event potentially having a dramatic impact on how much you pay for an overseas product or service.

These changes in currency pair values form the basis of the multi-trillion-pound foreign exchange (forex) industry, where millions of traders use forex brokers to help them trade currency pairs. For example, people trade GBP/EUR on the international market, in the hopes of profiting from sudden fluctuations in the exchange rate.

Forex brokers often take into account the daily developments that affect currency values when completing forex trades, and have a detailed understanding of how exchange rates work. Consider how the Pound lost 20% of its value against the Euro in the aftermath of the Brexit referendum.

That drop led to businesses and consumers paying more for European goods and services. Understanding how currency pairs fluctuate like this will help you approach future foreign transactions better prepared.


Who Do These Fees Go To?

You might be wondering; who benefits from currency conversion and foreign transaction fees? First off, it certainly will not be the business owner. All fees of this nature are charged at the payment terminal customers use, i.e. the credit and debit card reader. The fees are charged by the credit or debit card issuer in most cases, as these are the actors that are going through the trouble of processing and converting the payment.

With overseas cash withdrawals, the conversion and transaction fees are usually charged by the ATM network, meaning that the money from the fees will be going to the bank that operates the ATM being used. It's worth remembering that merchants do not benefit from conversion and transaction fees in any way, should a disgruntled customer accuse you of doing so.

Now you know everything you need to know about currency conversion ad foreign transaction fees. Make sure to let us know in the comments if you have any additional thoughts or questions.

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Written by:
Stephen Hart

Stephen Hart

Founder - Cardswitcher

Former - Chief Financial Officer @ Worldpay

Stephen brings a wealth of experience honed through years in the financial sector, particularly in the card processing payments industry. His illustrious career spans key roles at PwC, Natwest, and the role of CFO at WorldPay, before going on to found card processing comparison site, CardSwitcher. He is passionate about helping growing businesses to understand the card processing landscape so they can make savvy financial decisions.