Merchant Processing Explained

What is credit card transaction processing?

Credit card processing occurs when electronic transactions involving credit cards are authorized, authenticated, and settled between the cardholder, the business, and their respective financial institutions. This process allows businesses to accept credit card payments for goods or services, facilitating easy and convenient business and customer transactions.

Accepting credit cards allows you to receive payments, so you’ll have to choose a credit card processing company. Credit card processors are crucial partners that go beyond just processing payments, so choosing the right one is an important business decision. You don’t need to be an expert, but having an understanding of how credit card processing works will make you a more informed consumer.

Key participants in credit card processing

While credit card transactions are typically processed very quickly, what happens behind the scenes is complex. The process requires many components that collaborate with each other to ensure that funds move securely and efficiently.

Here’s an overview of the parties that participate in this process:

• Cardholder
  The cardholder is the individual who owns the credit card and uses it to make purchases for goods or services.
• Merchant
  The merchant is the business or service provider that accepts credit card payments from customers in exchange for goods or services.
• Point-of-sale (POS) system
  The POS system is the hardware and software the business uses to accept and process credit card transactions and includes terminals, card readers, and software applications.
• Payment gateway
  The payment gateway is a service that securely transmits transaction information between the business’s POS system and the credit card processor.
• Credit card processor
  The credit card processor, also called the “payment processor,” is a company that works with card networks and issuing banks to authorize, authenticate, and settle credit card transactions on behalf of the business.
• Card networks
  Card networks—such as Visa, Mastercard, American Express, and Discover—facilitate communication between credit card processors and issuing banks and set transaction rules and standards.
• Issuing bank
  The issuing bank, also called the “issuer” or “card issuer,” is the financial institution that issues the credit card to the cardholder. It authorizes and approves transactions, and it provides the funds for the purchase.
• Acquiring bank
  The acquiring bank, also known as the “acquirer” or “merchant bank,” is the financial institution that contracts with the business to accept and process credit card transactions. It settles funds with the issuing bank and deposits them into the business’s account.

How does credit card processing work?

Credit card processing happens in two steps: authorization and settlement. Although the authorization step — when a card is approved or declined — generally takes only a few seconds, the settlement stage is just as important to the merchant receiving its money.

Authorization

The cardholder starts the process by providing their card information through the merchant’s card-reading device. The card information is then sent to the merchant bank or the payment processor, which, in turn, routes the information through the appropriate card network to the issuing bank. After the issuing bank confirms the card details and checks the cardholder’s account status and available credit, it sends an approval or denial to the merchant bank. The merchant bank or payment processor then forwards the decision to the merchant’s card reader.

The authorization process for online and e-commerce card transactions may be slightly different and could require a payment gateway and a payment processor.

Settlement

In the settlement process, funds are moved from the issuing bank to the merchant account. Generally, merchants send batches of authorized credit card transactions to their merchant bank or payment processor at the close of business or another scheduled time. These transactions are routed to the card networks, which work with the issuing banks and merchant banks to ensure funds are deposited into the appropriate merchant account.

The issuing bank deducts interchange fees from the transaction amounts before transferring the funds to the merchant account. As a general rule, it takes one to three business days for the settlement process to be completed.

What’s needed to process credit cards?

A merchant will typically need hardware and software to capture the information needed to process a credit card transaction.

Hardware

The hardware for credit card transactions can be as simple as a compact card reader that plugs into a smartphone, or it can be a device with more features, such as a terminal, register or an entire point-of-sale, or POS, system. These devices collect and then transmit card data through the internet or a phone line to the merchant’s payment processor. Payment processors typically offer a variety of options when it comes to hardware.

Software

A payment app is generally needed for credit card processing. Some are free with the purchase of hardware, and others may require a monthly fee. These software programs can include features such as inventory management, customer tracking, the ability to send email receipts, and reporting and analytics.

How much are credit card processing fees?

In addition to the costs associated with the hardware and software, a merchant will also pay credit card processing fees. In general, total fees range from 1.5% to 3.5% of the transaction amount and involve three separate fees:

• Interchange fees: Interchange rates are set by the card networks, and fees are paid to the issuing bank. They’re typically the largest portion of the processing fees.

• Assessment fees: These fees are paid to the card networks.

• Payment processor fee: This fee goes to the payment processor, which may be the merchant bank or a third-party processor.

Merchants can pay additional fees based on the payment processor they use and the services provided. For example, some payment processors charge a fee for PCI compliance, while others don’t.