What is credit card processing? All Things You Need To Know

Credit card payments are an important part of any small business. However, if you’re not sure how to get started with credit card processing, this blog post is for you!...

Credit card payments are an important part of any small business. However, if you’re not sure how to get started with credit card processing, this blog post is for you! We wrote it so that its steps will be as simple as possible and equip you with the knowledge necessary to take credit cards for your small business activities.

What is credit card processing?

Credit card processing is a multi-step process used to complete payments made with credit cards. It includes many entities, including the consumer (person making the payment), merchant (seller of goods or services), payment gateway, credit card processor, an acquiring bank.

Which contributed to credit card processing?

Here are some of the entities that play a central role in how credit card processing works, to securely capture payments at POS.

Consumer: The cardholder, or the person making the purchase.
Merchant: The people or company that is selling the product or service to the consumer.
Payment gateway: This term generally refers to the technology that connects a merchant to a payment processor. This process involves integrating with card-present (i.e., in-store purchases) and card-not-present (i.e., online purchases) environments, obtaining customer transaction information, sending these details to a payment processor or bank, then getting an “approved” or “declined” message back from them for you as the merchant which they will share with you so that it is based on your business needs what response would be sent back such as approving or declining their request at checkout time and taking care of any other necessary steps like objecting if needed since this is often required by law in certain countries/states where chargebacks are possible
Credit card processors: Credit card processors are the entities that facilitate communication between merchants, credit card networks, and banks. They maintain compliance with the Payment Card Industry Data Security Standards (PCI DSS) by providing gateways to make electronic transactions possible while they focus on their core function of managing payments. Some payment processors provide their own gateways but many have reseller agreements with gateway providers.
Card network: A credit card network is the brand of a customer’s credit card, such as Visa, American Express, and Mastercard. Credit card networks are responsible for setting interchange fees that they charge to issuing banks or other financial entities that provide their cards to merchants on the network.
Issuing Bank: The issuing bank is also called the cardholder’s bank, or consumer bank. It provides your credit card and plays a big role in the settlement of any given transaction. One of its primary functions is to determine whether you have enough money in your account to complete a transaction and if so release those funds for settlement
Acquiring bank: The merchant bank holds a business’s funds and receives money from transactions. They can provide card readers and equipment to accept credit card payments, as well as serve as a processor for those transactions.

How Does Credit Card Processing Work?

There are three primary steps involved in credit card processing, which include authorization, authentication, and settlement.

Process Authorization

When a customer purchases something, they provide their credit card information to the merchant. This can be done at an in-person store or online, and it may involve entering the information into a website or swiping your card on a point-of-pay terminal. It could also happen over the phone where you give your details instead of swiping your card.
Then, the merchant sends a request for payment authorization to the payment processor.
The payment processor sends a request to the card association.
The card association will send this request to the customer’s issuing bank.
When the credit card issuer approves or denies a purchase, they will send a message to the card association. It will include your credit card number, expiration date, billing address, and security code as well as the transaction amount. You won’t be able to use your credit when you don’t have enough funds or if there are any suspicious activities on your account so it can be flagged and denied for security measures.
After receiving this request, the card association will send its approval or denial to the payment processor.
The payment processor will send its approval or denial to the merchant.
Once the merchant receives this update, it will share this approval or denial with the cardholder.
If a customer’s transaction is approved, the merchant will provide them with an item or service. However, denied transactions mean that the customers would have to use another payment method so they can receive their product or service.

Process Authentication

The second step is to verify the validity of the transaction. This must be done by the issuing bank.

The credit card association will request payment authorization from the customer’s issuing bank
The issuing bank will check that the cardholder account has been approved for the transaction and then verify any identifying information.
Next, the issuing bank will send its approval or denial to the card association and merchant bank.
The issuing bank will place a hold for purchase amounts on the cardholder’s account (i.e., it will show up as pending on the customer’s account).
All approved transactions for a merchant are processed on the POS terminal by the end of the business day.
The merchant will send the customer a receipt as proof of the purchase.

Process Settlement

This is the last step in credit card processing when a merchant receives funds from their customer’s bank. Keep in mind that the settlement phase can take a few days depending on which network they’re using.

The merchant’s POS sends the batched payment authorizations to the payment processor.
The payment processor sends the batch authorizations to the card association.
Then, the card association sends the key information to the issuing bank.
The issuing bank charges the cardholder’s account for authorized payments.
The issuing bank also subtracts any interchange fees for the card association and then transfers the remaining funds to the merchant’s bank.
Once received, the merchant’s bank distributes the money to the merchant’s business account.
Finally, the issuing bank updates the customer’s account statement to reflect the recent transaction.

What does credit card processing cost?

Credit card processors typically charge a processing fee for every credit card payment you accept. Some processors will charge more fees depending on what pricing model the processor uses, though.

Processing fees

Transaction fees can be divided into two primary kinds: wholesale and markup. Wholesale fees, also known as “interchange” fees, are charged by the issuing bank and the card network. Markup rates on credit cards are negotiated with your processor or payment gateway. Unlike wholesale rates, which cannot be negotiated, markup rates can change depending on what you’re willing to pay for them!

Here are the three types of credit card processing fees you should know about:

Interchange Fee: The interchange fee is the wholesale charge mentioned in this passage. This is a standard, non-negotiable rate that covers the costs of processing and verifying transactions as well as fraud protection associated with credit card processing. Collected by consumers’ issuing banks from merchants at their point of sale, retailers are charged an interchange fee each time they complete a transaction—with rates on average being about 1.8% for credit cards or 0.3% for debit cards but varying widely according to the type of card used in a purchase process (e.g., premium or rewards).
Assessment or Service Fee: This is another form of non-negotiable fee the card network charges. This fee typically ranges from a small percentage to how much you use your card and can be affected by your transaction volume or risk level as assessed or calculated by the networks.
Processing Fee: There are different fees for each payment processor, and these vary depending on the pricing plan. This is known as a payment processor’s “markup”, and it differs from one to another.

Kind of payment processor pricing models

Payment processors use a variety of pricing models. The four you are likely to encounter when choosing one are:

Flat rate: The processor charges a fixed fee for all credit and debit card transactions, regardless of the card used. This means that card-present transactions often have a lower flat rate than those from when cards are not present. The rates vary depending on how risky it is to process the transaction at any given point in time; this can be structured as either just a simple base rate (for example 2.9%) or as both an initial base rate plus an additional small per-transaction amount (such as 2.9% + $0.30). Merging wholesale and markup fees together rather than separating them makes sense here because they are dependent on one another: if you pay with cash instead of your debit/credit card, then there will be no merchant’s markup fee charged by the bank which processes your payment simply because there was no cost involved in processing it! Tiered: The processor charges a fee based on the card type used in the transaction, how much risk is associated with that particular transaction, and the overall volume of transactions your business does. This model is considered to be one of three models which are most complex and potentially confusing for merchants.

Interchange Plus: The Interchange Plus pricing model is the most common and transparent way for a merchant to pay. Here, the merchant pays a percentage of each transaction (plus one fixed per-transaction fee). This separates wholesale fees from markup fees; for example, if someone makes a $100 payment with a Visa Rewards credit card then their effective rate will be 2.13%.

Subscription: The processor charges a flat service fee and a small per-transaction fee, along with the wholesale price. The markup pricing model is charged separately from the transaction processing fees.No matter which pricing model your business selects, note that not all transactions clear at long periods of time or at the same rate; qualified transactions are processed more cheaply than non-qualified ones.

Read more:

What is a Merchant Card Processor Account?