Credit Card Processing What Is It and How It Works best guide 2022

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You can use this guide if you’re interested in accepting credit card payments for your small business but don’t know where to begin.

It shouldn’t be a source of stress to process credit card payments routinely. Our goal with this guide is to make the process of setting up credit card processing as simple as possible.

How does credit card processing work?

Credit Card Processing

Here’s a quick overview

The credit card processing process consists of the steps involved in making a payment by credit card in person, online, by phone, or by mail.

How does credit card processing work?

To securely capture payments at the point of sale, credit card processing relies on the following entities.

  • Customers. The customer making the purchase.
  • Retailer. This is the person or business who sells the product.

They process the payments. A payment processor connects merchants with payment processors. A payment gateway typically integrates with in-store and online payment environments, captures payment details for customer transactions and routes them to a payment processor or the merchant bank, as well as sends a message that indicates whether the transaction was approved or declined.

The payment processor takes credit card payments. Known more generally as a “payment processor.” An organization that facilitates communication between merchants, credit card networks, and the banks of cardholders.

Payment Card Industry Data Security Standards (PCI DSS) compliance is the responsibility of both processors and merchants. Typically, the larger payment processors have reseller agreements with payment gateways. Some payment processors provide their own payment gateways.

There are also payment networks. This name is also used for “credit card networks” or “credit card brands.” These are the various brands of credit cards, such as American Express, Visa, Mastercard, and Discover. Chargebacks and assessment fees are set by credit card networks. PCI DSS standards are developed by the networks.

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The issuing bank develops them. A bank that provides the customer with a credit card. It is also called a “cardholder’s bank” or a “consumer’s bank.” Its primary function in the credit card processing cycle is to verify that the cardholder has the funds to complete the transaction and to release those funds.

A bank that accepts the credit card. It is also known as the “merchant bank.” This is the bank where the merchant keeps their funds and where they receive money from transactions.

The bank can provide the merchant with card readers and equipment to accept credit cards. The acquiring bank can also handle credit card processing.

Merchant banks and merchant accounts are not to be confused with merchant accounts. A merchant account is an account that temporarily holds the funds from credit card (and debit card) transactions.

It simply serves as a holding account for these funds as they are transferred to your business banking account at the end of the settlement process. As the merchant, you do not have direct access to this account.

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A description of how credit card processing works

How does credit card processing work
  • Processing credit cards is initiated by the consumer: the customer uses their credit card to make a payment, and the merchant receives payment information.
  • Payment information is collected by the merchant in one of two ways: a.) in person during a “card-present” transaction, or b.) online or by telephone during a “card-not-present” transaction.
  • Following this, the information is sent to the credit card processor, which then sends it to the card network.
  • Once the payment information is received by the card network, it is forwarded to the consumer (issuing) bank.
  • To complete a transaction, the consumer bank must verify that the cardholder has sufficient funds or credit. To ensure the transaction is authentic, the bank may also run security protocols. The transaction is then approved or declined, and the decision is communicated to the credit card processor.
  • Insufficient funds, exceeding the credit limit, and unauthorized purchases (for example, if the card has been reported lost or stolen) are the three most common reasons for a declined transaction.
  • In the event that the transaction passes the consumer bank’s verification process, the funds are released from the consumer bank to the merchant account, and the transaction enters the settlement process (see step 8).
  • Ultimately, the notification travels back to the merchant from the consumer bank and results in a message displayed on the card reader or virtual terminal letting the merchant know whether the transaction has been approved or denied.
  • The payment settlement is the final step in the process, which can take a few days depending on the card network involved. The settlement process involves transferring the transaction amount from the consumer bank to the merchant bank minus any applicable fees.
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Deposits in a bank: what you need to know

As mentioned above, the merchant receives the funds from the cardholder’s bank once the transaction has been approved. Funds are then transferred to the merchant’s bank account. In some cases, the sale or transaction amount does not reflect the amount of a bank deposit, depending on your payment processing terms and the frequency with which fees and other charges are deducted.


Credit Card Processing What Is It and How It Works best guide 2021 13

Check out our guide to learn more about bank deposits.

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How much does credit card processing cost?

Processing fees are usually charged by credit card processors for every credit card payment you accept. It may be necessary to pay additional fees according to the pricing model used by your processor.

Fees associated with processing

online credit card processing

The two primary kinds of transaction fees are wholesale and markup. The issuing bank and the card network charge wholesale fees also called “interchange fees.” Payment processors and payment gateways charge markup fees. Markup fees are negotiated rather than wholesale fees.

Processing fees for credit cards fall into three categories:

The exchange fee. This is the same as the wholesale fee mentioned above. An industry standard, the non-negotiable fee is charged to cover the cost of processing the transaction, the risk of payment approval, as well as the risk of fraud and bad debts.

Each card network determines the interchange fee based on the percentage of the transaction total and the set transaction fee collected by the issuing bank. Payment processing fees are the largest cost of credit card processing and are typically influenced by the type of card used.

In the U.S., the average interchange rate for credit cards is about 1.8% and for debit cards, it is about 0.3%. The actual interchange rate charged to a merchant can vary widely, however. A premium or rewards card’s interchange fee, for example, is generally higher.

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Service fee or assessment. Again, it’s a non-negotiable fee, but this time it’s a network fee. This fee is typically a small percentage and depends on the volume of transactions and the card networks’ assessment of your risk level.

Fees associated with processing. There is a fee associated with each payment processor. The markup depends on the pricing plan of the payment processor and is known as the payment processor markup.

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Pricing models used by payment processors

cheapest credit card processing

Various pricing models are employed by payment processors. If you are choosing a payment processor, you will probably encounter these four factors:

There is no rate difference. All credit or debit card transactions are subject to a simple fixed fee, regardless of the payment method. A card-present transaction often has a lower flat rate than a card-not-present transaction because they carry less risk.

For example, 2.9% may be included in the base rate, or 2.9% may be included in the base rate plus $0.30 per transaction. In this model, wholesale and markup fees are merged instead of being separated.

Levelled. Based on the type of card used, the amount of risk involved, and the volume of transactions, the processor charges a fee. Merchants may find this model confusing because it is the most complicated.

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Plus Exchange. A common pricing model is Interchange Plus, which is often considered transparent and cost-effective. There is a percentage fee and a fixed fee per transaction payable by the merchant.

Therefore, the wholesale fee (the “interchange”) is clearly distinguished from the markup fee (the “per transaction”). If a $100 payment is made with a Visa Rewards credit card, any additional fees charged by the credit card processor are included in the total (effective) rate, which is 2.13%.

Membership. As well as a flat monthly fee, the processor charges a small per-transaction fee. Markup fees are separate from wholesale fees.

You should keep in mind that not all transactions clear at the same rate, regardless of the pricing model you choose. In qualified transactions, the processing rate will be lower than in nonqualified transactions.

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