What is Credit Card Processing and How Does it Work

In today’s digital and cashless economy, credit card processing has become a fundamental aspect of running a business. It’s a system that enables merchants to accept payments from customers using credit or debit cards. Whether you are running a brick-and-mortar store, an online business, or a mobile service, credit card processing is essential to offering your customers the flexibility to pay via their preferred methods.

This comprehensive guide will explain what credit card processing is, how it works, the key players involved, and the different types of payment processing methods available. Additionally, we’ll explore security measures, associated costs, and frequently asked questions to help businesses understand the complexities of credit card processing.

Understanding Credit Card Processing

Credit card processing is the procedure through which a merchant accepts payment from a customer via a credit or debit card. It involves several steps, including authorizing the payment, transferring funds from the customer’s bank to the merchant’s account, and ensuring that the transaction is secure.

At the most basic level, credit card processing can be broken down into three core components:

1. Authorization – The process of verifying that the customer has enough credit or funds to cover the purchase.
2. Authentication – The process of confirming that the cardholder is the person making the purchase.
3. Settlement – The transfer of funds from the customer’s bank account to the merchant’s account.

How Does Credit Card Processing Work?

Credit card processing is a multi-step process that involves several key players, including the customer, the merchant, the payment processor, the issuing bank, and the acquiring bank. Here is a breakdown of how credit card processing works:

1. Cardholder Initiates a Transaction

The credit card processing journey begins when a customer (the cardholder) presents their credit or debit card to make a purchase. This can be done either in person, through a point-of-sale (POS) system, or online by entering card details into a payment form.

2. Merchant Receives Payment Information

Once the customer provides their card information, the merchant uses a credit card terminal or payment gateway (for online transactions) to capture the card details. This information includes:

• Card number
• Expiration date
• CVV (Card Verification Value) code
• Cardholder’s name

3. Transaction Sent to Payment Processor

The merchant’s POS system or payment gateway then sends the transaction details to a payment processor. The payment processor is the company responsible for routing the transaction details between the various parties involved in the transaction (merchant, issuing bank, and acquiring bank). Payment processors also ensure that the transaction complies with industry regulations.

4. Transaction Sent to Card Networks

The payment processor forwards the transaction details to the appropriate card network, such as Visa, Mastercard, American Express, or Discover. The card network checks the validity of the card and forwards the transaction to the cardholder’s issuing bank for authorization.

5. Issuing Bank Authorizes the Transaction

The cardholder’s issuing bank receives the transaction request and verifies whether the customer has enough available funds or credit to complete the purchase. If approved, the issuing bank sends an authorization code back to the card network, which is then routed to the payment processor and finally to the merchant’s system.

If the transaction is declined (due to insufficient funds or other reasons), the issuing bank sends a decline message to the card network, and the transaction is halted.

6. Merchant Receives Authorization and Completes Transaction

Once the merchant receives the authorization code, the transaction is approved, and the merchant provides the goods or services to the customer. At this stage, the customer’s available credit limit is reduced by the amount of the transaction, but funds have not yet been transferred.

7. Batching and Settlement

After the day’s transactions are complete, merchants typically “batch” all authorized transactions and submit them for settlement. The payment processor collects the batched transactions and forwards them to the card networks, which then communicate with the issuing banks to initiate fund transfers.

8. Funds Deposited into Merchant’s Account

Once the funds are cleared, the acquiring bank (the merchant’s bank) deposits the transaction amount into the merchant’s account, minus processing fees. This process can take one to three business days.

Key Players in Credit Card Processing

Credit card processing involves several entities working together to ensure the smooth transfer of funds. Each plays a specific role:

1. Cardholder – The individual or business that owns the credit or debit card being used for the transaction.
2. Merchant – The business or individual accepting the credit card payment in exchange for goods or services.
3. Payment Processor – A company responsible for processing the payment on behalf of the merchant. It routes the transaction information between the merchant, issuing bank, and acquiring bank.
4. Card Network – Major card brands, such as Visa, Mastercard, American Express, and Discover, that act as a bridge between the merchant and the issuing bank. They ensure the transaction adheres to industry rules.
5. Issuing Bank – The financial institution that issued the credit or debit card to the cardholder. It authorizes or declines transactions and facilitates payment to the merchant.
6. Acquiring Bank – The bank that manages the merchant’s account and facilitates the deposit of funds into the merchant’s account after settlement.

Types of Credit Card Processing Methods

There are several methods available for businesses to process credit card transactions. Each method is suited to different types of businesses and sales environments:

1. Point-of-Sale (POS) Systems

POS systems are used by retail stores, restaurants, and other businesses that process in-person transactions. These systems integrate credit card processing with sales and inventory management. The cardholder physically presents their card, which is either swiped, inserted (for EMV chips), or tapped (for contactless payments).

2. Mobile Credit Card Readers

Mobile card readers connect to a smartphone or tablet via Bluetooth or audio jack and allow businesses to accept payments on the go. This method is particularly useful for service providers, food trucks, and mobile vendors.

3. Online Payment Gateways

For eCommerce businesses, an online payment gateway allows merchants to accept payments from customers who enter their card details on a website. The gateway acts as a virtual terminal and securely transmits payment data to the payment processor.

4. Virtual Terminals

Virtual terminals enable businesses to accept credit card payments without needing a physical card reader. Merchants manually enter the customer’s card details into an online form. This method is useful for phone orders, email invoices, and remote transactions.

Credit Card Processing Fees

One of the most significant considerations for businesses is the cost of credit card processing. Several types of fees are typically associated with credit card transactions:

1. Interchange Fees

Interchange fees are paid by the merchant to the issuing bank. These fees are a percentage of the transaction amount, typically ranging from 1.5% to 3.5%, depending on the card type and transaction method.

2. Processing Fees

Payment processors charge merchants a fee for handling the transaction. This can either be a flat fee per transaction or a percentage of the total transaction amount.

3. Assessment Fees

Card networks like Visa and Mastercard charge assessment fees to cover their costs for handling and settling transactions. These fees are generally small but vary depending on the card network.

4. Monthly Fees

Many payment processors charge a monthly fee to cover the cost of maintaining the merchant’s account. This may include access to customer support, software updates, and compliance management.

5. Chargeback Fees

If a customer disputes a charge, resulting in a chargeback, the merchant may incur a chargeback fee. These fees are typically between $15 and $100 per chargeback and may also result in the transaction being reversed.

Security Measures in Credit Card Processing

Credit card security is critical for businesses and consumers alike. Given the rise in data breaches and payment fraud, merchants must take steps to ensure that customer payment information is protected. Some key security measures include:

1. PCI-DSS Compliance

The Payment Card Industry Data Security Standard (PCI-DSS) is a set of security requirements that businesses must follow when handling cardholder data. These standards ensure that sensitive information is protected from theft and misuse.

2. Encryption

Encryption ensures that payment data is unreadable to unauthorized parties as it moves through the payment network. This prevents hackers from intercepting and misusing sensitive information.

3. Tokenization

Tokenization replaces sensitive card details with a unique identifier (token) that can be used for future transactions. The token itself is useless without the original data, which is stored securely by the payment processor.

4. EMV Chip Technology

EMV chip cards contain a microchip that generates a unique transaction code each time the card is used. This code cannot be reused, making it difficult for fraudsters to replicate card information.

5. Address Verification Service (AVS)

AVS helps verify the billing address provided by the customer matches the one associated with the credit card. This prevents unauthorized transactions using stolen cards.

Frequently Asked Questions (FAQs)

Q.1: What is the difference between a payment gateway and a merchant account?

A payment gateway is a service that securely captures and transmits payment information from the customer to the acquiring bank for processing. It acts as a bridge between the merchant’s website or point of sale system and the acquiring bank. A merchant account, on the other hand, is a bank account that allows businesses to accept and process credit and debit card payments. While a payment gateway handles the transmission of payment data, a merchant account facilitates the settlement of funds.

Q.2: How long does it take for funds to be deposited into my account?

The time it takes for funds to be deposited into a merchant’s account can vary depending on factors such as the acquiring bank, the card network, and the merchant’s processing agreement. In general, funds are typically deposited into the merchant’s account within one to three business days from the date of the transaction.

Q.3: Can I accept credit card payments without a physical card reader?

Yes, it is possible to accept credit card payments without a physical card reader. With the advent of mobile credit card processing and online payment gateways, businesses can accept card payments using smartphones, tablets, or their website. Mobile credit card processing involves using a mobile card reader that connects to a mobile device, while online credit card processing allows customers to enter their card information directly on a website.

Q.4: What happens if a customer disputes a charge?

If a customer disputes a charge, the issuing bank initiates a chargeback process. The merchant is notified of the dispute and may be required to provide evidence, such as proof of purchase or delivery, to support their case. The acquiring bank then investigates the dispute and may debit the merchant’s account for the disputed amount if the chargeback is upheld. Chargebacks can result in additional fees and potential damage to the merchant’s reputation.

Q.5: Is credit card processing secure?

Yes, modern credit card processing includes encryption, tokenization, and compliance with PCI-DSS standards to ensure the security of transactions and protect against fraud.

Conclusion

Credit card processing plays a vital role in today’s business landscape, enabling businesses to accept and process card payments securely and efficiently. Understanding the basics of credit card processing, the role of merchant accounts, different processing methods, security measures, fees, benefits, drawbacks, and frequently asked questions is essential for businesses and consumers alike.

By implementing robust security measures, choosing the right merchant account provider, and understanding the costs and benefits, businesses can leverage credit card processing to enhance their operations and provide a seamless payment experience for their customers.