Credit Card Processing 101
Oct 24, 2022
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Today's marketplaces are getting increasingly digitized, making it critical for businesses to quickly adapt to new technologies. As more and more people prefer paying with credit cards, you should be ready to accept credit card payments unless you want to lose your customers.
If you're considering taking credit card payments but are unsure where to start, stay with us. This guide will walk you through the ins and outs of credit card processing.
What is credit card processing?
Credit card processing is a set of steps to complete a payment made with a credit card. Credit card transactions can occur in a variety of ways: in person, online, over the phone, or even by mail.
Parties involved in credit card processing
Credit card processing involves several participants:
Cardholder
The cardholder is an individual who gets a card from an issuing bank and uses their bank account to make payments by inserting a chip card, tapping a tap-to-pay card, or entering card details on a payment portal.
Merchant
The merchant is a business that provides goods or services in exchange for payments. Merchants offer a card machine for their customers to use cards. They are required to cover processing fees to the bank or card company as well as comply with PCI-DSS (Payment Card Industry Data Security Standard). To keep sensitive card data away from a merchant's system and reduce the scope of PCI-DSS requirements, data tokenization tools are used.
Acquiring bank
The acquiring bank transmits the card and transaction data to the card network. Acquiring banks often provide merchants with credit card processing equipment and merchant accounts.
Card network
The credit card networks — Visa, Mastercard, American Express, and Discover — act as a bridge between the acquiring and issuing banks. Card networks are responsible for receiving credit card payment data from acquiring processors, sending payment authorization requests to issuing banks, and delivering the issuing banks' responses to the acquiring processor.
Issuing bank
As its name suggests, the issuing bank refers to the bank that issued the card to the cardholder. It is responsible for authorizing credit card details and paying the acquiring bank.
Credit card processing step-by-step
Although happening in a matter of seconds, credit card processing involves several steps.
1. Initiating the payment
The customer initiates a payment by swiping, dipping, tapping a physical card, or entering card details online, sharing the card information with the merchant.
2. Authorization
The merchant's credit card machine transmits the card data and transaction details to the acquiring bank through the internet or phone line. Next, the acquiring bank forwards this information to the appropriate card network. After that, the card network sends the information to the cardholder's issuing bank.
3. Approval
Once the merchant bank approves the transaction, the cardholder receives the payment receipt. Still, the merchant isn't paid at this stage.
4. Processing
At the end of the working hours, the merchant sends all credit card payment receipts to the bank. The bank forwards these receipts to appropriate payment networks for further processing.
5. Credit card charges
The card network contacts the issuer regarding the due payments. The card issuer keeps a certain percentage of the fee per the agreement.
6. Merchant payment
Once the credit card company collects their fee (typically 2%), they transfer the remaining amount to the merchant.
Costs associated with credit card processing
With modern customers preferring to go cashless, it's crucial to be able to process credit card payments if you want to stay competitive in the market. However, the whole thing is more complicated than opening a merchant account and getting a credit card machine. The credit card transaction process is associated with some extra costs. Let's take a closer look at them.
Merchant discount rate
Merchants are charged this fee for accepting and processing card payments. The merchant discount rate normally ranges between 1 and 3 percent of the purchase price after taxes. However, eCommerce merchants should expect to pay a higher rate due to extra security costs. The merchant discount rate is made up of the following components:
Interchange fees
These are paid by the merchant's bank and acquiring processor to the issuing bank when their cardholder buys the merchant's product or service. Importantly, interchange fees are not static. For example, Visa and Mastercard update their interchange fees every April and October and differentiate their rates according to the card type, transaction type, business size, etc.
Assessment fees
Assessment fees are flat rate fees merchants pay to the credit card networks.
Markup fees
Markup fees cover the cost of processing card payments charged by a payment processor.
Chargeback fees
A chargeback occurs in the case when a customer disputes a charge on their card with their issuing bank, requesting that their bank remove the charge. This can happen for various reasons, most typically credit card fraud or not receiving the goods.
After the customer places the request, the bank starts the chargeback process, which suggests holding the disputed funds until the dispute is finalized. The exact rate paid by the merchant can dramatically vary depending on the acquiring bank, processor, and other factors. For instance, fees are usually higher for merchants with numerous disputed charges.
Parting thoughts
The convenience credit cards offer to cardholders is indisputable. Still, while credit card transactions are quick and easy on the customer's side, the behind-the-scenes of this process are way more complicated. Accepting card payments is a must if you want to survive in today's competitive business landscape, and it's worth knowing the basics of credit card processing before you put a credit card machine on your counter.