How to get the best currency conversion rate

Few travel issues vex travelers more than currency conversion. It sometimes appears that the travel industry tries to make the subject more complex than it really is, and even through the amounts of money involved are usually fairly small, many travelers seem to feel that the system is cheating them.

A recent reader question illustrates uncertainty about “dynamic conversion,” one of the newest wrinkles: “When I use my credit card in Europe, the credit card machine gives me an option to choose euros or dollars for the transaction. Which currency should I choose to get better currency rate?”

The quick answer: You’re almost always better off asking to be billed in local currency. To understand why, you have to know a bit about how MasterCard and Visa—and the banks that issue these cards—treat transactions in foreign currencies.

The basic process

When you use your card to make a purchase in a foreign currency, the international MasterCard or Visa network makes the actual conversion. The merchant’s bank credits the merchant’s account with the purchase in local currency and passes the charge along to the international MasterCard or Visa network, depending on the card. The network converts the charge from local currency to dollars, and sends the dollar charge to the U.S. bank that issues your card. The network adds a fee of one percent to the conversion process, which it bills to your bank. Your bank debits your account by the dollar charge—and usually more.

The three-percent scam

Most U.S. banks that issue MasterCard and Visa cards now add a three- or three-and-a-half-percent surcharge to any charge originating outside the U.S., regardless of the currency in which the charge originates. As you can see, the bank provides no conversion service to “earn” that surcharge—the debit for your account that it receives from overseas is already in dollars. It’s an outright scam, and the banks do it because they can, not to offset the cost of any useful financial service. Since the bank has to pay the one percent fee to the international network, the actual scam amounts to two or two-and-a-half percent of each billing.

A few U.S. banks do not assess the surcharge. The most notable is Capital One, which doesn’t even add that one percent fee. According to my latest check, other banks that don’t add a surcharge (but may add the one percent) include USAA, HSBC, Nationwide, and a number of smaller banks and credit unions.

Dynamic conversion

Dynamic conversion modifies the process described above. In this case, a local merchant originates the charge in dollars. Some merchants give you a choice; others automatically charge in dollars when they receive a U.S.-issued credit card. With a charge in dollars, the merchant’s bank converts your charge to local currency and credits the merchant’s account. Your debit, in dollars, goes through the international network to your bank, which treats it the same way it would a converted debit.

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The risk of dynamic conversion is that you take a double conversion hit:

• Each local merchant sets the rate at which it converts your charge to U.S. dollars, and you usually have no idea of how good—or bad—that rate might be. You know it’s likely to be bad, since the credit card companies promote dynamic conversion to merchants as an additional “revenue stream.” In theory, a merchant could add 10 percent or more and you wouldn’t know. I haven’t heard from readers or seen any industry data indicating what rates travelers actually encounter, but I’m pretty sure they’re not good.
• Even when a merchant converts your bill to dollars, you don’t escape your bank’s three-percent or three-and-a-half-percent fee. As long as the transaction originates outside the U.S., you pay.

You may find one exception. Planet Payment claims that its dynamic conversion rates are as good as those you get through the more usual system. I haven’t had a chance to check it out personally, but that’s the claim. The problem, as I see it, is that you can’t be sure which local merchants use that system as opposed to any others.

American Express or Diners Club

America Express operates a bit differently. AmEx acts as both issuing bank and international network, so there’s no separation of fees. You pay about two percent, total, on overseas transactions.

Diners Club formerly operated the same way as AmEx, but the Diners Club card now seems to have devolved into a conventional Citibank MasterCard with a few special features.

What to do

Overall, I see far more risks and fewer benefits from using dynamic conversion than from getting your charges in local currency.

• Always ask for a charge in local currency.
• If you bill a lot of overseas spending on a credit card, get a card that doesn’t add the surcharge.

Otherwise, two percent of your foreign purchases is a pretty small number of dollars. Use your regular card and concentrate other ways of cutting your travel costs by more than two percent.