How to calculate foreign exchange fees

Last Updated on December 9, 2023 by admin

Being an exchange platform or broker isn’t easy. They need to pay for a lot of infrastructure and tech to match buyers and sellers in vast quantities, all whilst keeping transactions safe, reliable, and speedy. To raise revenue for this, they charge a spread, fee, and or commission. Here is a breakdown of each. It’s also important to bear in mind that bank transfer rates are often the worst.

Spread

The natural difference between the buy and sell price is called the spread. If a currency was somehow under-priced with a low bid price, people would buy it (potentially for an arbitrage strategy) and it would cause the demand to rise, thus the price would rise, and we would be back into equilibrium.

In a theoretically perfect market where liquidity (amount of buying/selling) is extremely high with zero friction, the spread would be minimal. However, high volatility and low liquidity can cause a larger spread.

Another reason for a spread though is that the exchange will often pocket the difference, thus creating an artificially larger spread. This is one key way for them to make money (often without stating it clearly). Some opt for a fixed spread and some offer a variable (floating) spread. If a platform claims they’re offering you the inte-rbanking rate (the foreign exchange rate that banks get their hands on) then this is a suggestion that there is no significant spread.

Commission

Fees and commission are very similar and there is an argument that they overlap – making this about semantics. However, to keep things simple in your mind, there are two ways that a broker can profit from your exchange beyond the spread: Charging a flat fee or commission.

One example of commission is Wise’s 0.5% charge (for most customers and for common currency routes) – as well as Revolut’s claim to charge 0.5% when having exceeded the free exchange monthly allowance.

These forms of commission are applied to the transfer amount. Thus, the amount you pay rises along with your transaction amount. A $1,000 exchange would cost $5 whilst a $10,000 exchange would cost $50.

This keeps things proportional and seemingly fair. Small, frequent exchanges aren’t unfairly punished, and the costs of your future costs are easy to remember.

Fees

There are different types of fees and such, but we can generally think of these as being a fixed cost, not variable. This isn’t everyone’s definition, but it’s important to understand the differences between fixed and variable costs.

An example of such a (fixed) fee is when sending money overseas using a high street bank. They will often charge a margin (another name for spread) of around 3%-5%, which is exportation in and of itself, but on top of that there may be a $/£ 30 flat fee.

This is applied regardless of the transaction amount. So if you send $30 to a EUR bank account, you’re charged $30 for doing so, rendering small transactions costly or even redundant

How to Calculate Forex Costs

So first and foremost, it’s important to understand standard Forex pricing. In the news and on many platforms, the standard way of stating the currency rate is by saying “EUR-USD 1.09”.

This means that to buy one Euro, you need 1.09 USD – it’s important to get this the right way around. As a side note, if you see in the news that “EUR-USD change is -8%” then it means that you’re getting 8% less USD per 1 Euro. This would be described as a strengthening of the Dollar and a depreciation of the Euro. In other words, it’s probably a good time to buy Euros and an expensive time to buy Dollars.

Back to the calculation. If the bank or broker is claiming it will cost you 1.12 USD but Google is saying the real rate is 1.09, then you have enough information to calculate the markup. Simply take the difference between the rates (it will be a positive number) and divide it by the real rate that you  found on Google. So, 0.03 is the difference between 1.12 and 1.09, meaning the calculation is 0.03/1.09 = 0.02752. Take this number and multiply it by 100 to get the %.

The number you end up with is 2.75%. This means that 2.75% of the amount you want to send is what it will cost to send. Any fees that are on top of this markup should be denoted clearly as another percentage (i.e. 0.5% commission) or a flat fee (i.e. $30).

You can divide the flat fee by the total amount you wish to send to convert it to a percentage, in which case you can then add up all the percentages to have a final figure of what it will cost.

To get the best currency rate, look for an fx rate of around 1% or under.