Credit Card Processing Guide

What is credit card processing?

Credit card processing allows you to accept credit card payments and includes everything that goes on behind the scenes from the time that a customer hands you a card as payment until you receive the money in your account. This process takes place whether the purchase is made in person, online, over the phone, or by mail. To accept credit cards, your business needs to be set up with one or more providers whom you will pay on a per-transaction basis and sometimes a monthly fee. You will also need software and, for in-person sales, card processing hardware.

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How does credit card processing work?

To understand how credit card processing works, you need to understand the various players involved. 

Who is involved?

There are more entities involved in credit card processing than you might think. Here is a list of them:

• Consumer: The cardholder and usually the purchaser.
• Merchant: You, the individual or business selling the products and services that the consumer is buying.
• Credit card processor: The company that handles communication between the merchant, the credit card network, and the cardholder’s bank, ultimately depositing the money into the merchant’s bank account. Some credit card processors have their own payment gateway, while others use third-party gateways.
• Payment gateway: The technology that encrypts credit card information and sends it from the merchant to the credit card processor. It is usually a stand-alone product for online credit card transactions and other purchases where the card is not physically present. For card present transactions, this technology is integrated into card reader hardware.
• Card network: The brand of credit card, such as Visa, Mastercard, American Express or Discover. These major brands set the interchange and assessment fees and create the security standards for PCI compliance.
• Issuing bank: The cardholder’s bank, which may or not be the same bank they use for their checking account. It is the bank that issued the credit card to the consumer and is responsible for letting the payment gateway or credit card processor know whether the consumer’s account has enough available credit to cover the transaction.
• Acquiring bank: The merchant’s bank, where you have your bank account. Once the transaction is complete, the money goes into your account at the acquiring bank.
• Merchant account services provider: The best merchant account services providers give you a temporary account that holds the funds until they are deposited in your account at the acquiring bank. Some credit card processors have their own merchant account; with others, you would need to get a third-party provider. Typically, you will only need a separate merchant account if you are exclusively using a payment gateway.
• Credit card facilitator: A company that does credit card processing for merchants under its own merchant account and payment gateway, rather than assigning each merchant its own merchant account and gateway like a credit card processor. They charge one fee for all card transactions, no matter which card network. Examples are PayPal and Square.

What are the steps?

These are the steps that take place in a credit card transaction:

1. A consumer buys a product or service from a merchant and provides a credit card as payment.
2. The merchant either accepts the credit card in person using a credit card reader, or online, by phone, or by mail through a payment gateway, POS software, or other credit card processing software provided by the credit card processor or facilitator.
3. The payment information is sent through the software or hardware to the credit card processor or facilitator.
4. The credit card processor or facilitator then passes the payment information to the card network.
5. The card network sends the payment information to the issuing bank.
6. The issuing bank verifies that the cardholder has enough money or credit in the account to complete the transaction. It runs a security protocol to verify that the purchase is legitimate and approves or declines the transaction. 
7. If the transaction is approved, the issuing bank starts the settlement, which is the release of funds from the consumer’s account to the merchant’s account.
8. The approval/denial notification is communicated back to the merchant.
9. The settlement is completed (this may take several days, depending on the card network involved) and the money for the sale is transferred into the merchant’s bank account, minus processing fees. Most credit card processors gather together individual transactions and deposit them in a batch at the end of each day.

Credit card processing security and PCI

Merchants, credit card facilitators and credit card processors are responsible for adhering to certain security protocols called the Payment Card Industry Data Security Standard, or PCI DSS for short. These requirements ensure that cardholder data is protected from internal misuse and data breaches. It includes computer safeguards such as firewalls and encryption, as well as personnel policies like assigning a unique ID to each person with computer access and restricting access to cardholder data to only those who need it for business processes. 

PCI compliance is necessary; a noncompliant company could face hefty fees. If you have a traditional merchant account with a bank or independent company, you will usually be responsible for your own PCI compliance. Credit card processors provide PCI compliance either by charging for it separately or bundling it into their monthly fee. They offer this compliance at no extra charge, but have somewhat higher transaction fees to cover this cost, among other things. 

Card-present transactions are the most secure, since the card reader hardware provides a lot of the verification, especially with chip readers and debit transactions that allow the customer to use a PIN. That is why transaction fees on this kind of sale tend to be the lowest. When a credit card is not physically present, there is a higher incidence of fraud, resulting in higher fees.

Credit card processing rates and fees

Since so many different organizations are involved in credit card processing, there are various credit card processing rates and fees. Rates are transaction-based and include a percentage of the overall purchase amount and sometimes a flat per-transaction amount. Fees are charged either on a monthly basis or only when certain events occur, such as a chargeback.

Some rates and fees are paid to the card network, some to the credit card processor or facilitator, some to the issuing bank, and, if you have a payment gateway, to the gateway provider. 

Credit card processing rates

This is usually a percentage of the sale amount, and sometimes a per-transaction fee. 

A credit card processing rate breaks down into three components: 

• Interchange rate: This portion of the rate is set by an organization of card networks and is paid to the cardholder’s issuing bank. The amount depends on the brand of card, whether it is credit or debit, and if it offers rewards. The interchange rate is non-negotiable.
• Assessment rate: Also set by the card networks, this amount goes to the card brand that was used for the transaction. Like the interchange rate, it is non-negotiable.
• Processor’s markup: The remainder goes to pay the credit card processor, and accounts for the differing rates among processors. Since this can depend on a variety of factors, such as monthly processing volume, average ticket size, and merchant history, it is negotiable.

Credit card processing fees 

Some credit card processors charge a monthly fee in addition to the processing rates. This may be a bundled fee that includes a variety of services, or it may be a separate charge for each service used. Here are some of the common fees:

In addition to these regular fees, credit card processors may charge incidental fees when certain events take place.

• PCI noncompliance fee: If you fail to implement certain security measures, you may incur a monthly fine until the issue is fixed.
• Chargeback fee: When customers want their money back, the entire credit card processing happens in reverse, and often results in a fee.
• Nonsufficient funds fee: You will be charged this fee if your bank account does not have enough funds to pay owed fees to the credit card processor. 

Benefits of accepting credit cards at your business

You may wonder if it is worthwhile to accept credit cards. After all, there is a lot of setup involved, and it costs you money when a customer pays with a card rather than cash. But more and more people do not carry cash with them, and this trend is accelerating among Millennials and Gen Z consumers. In addition to using credit cards, younger consumers often use cashless payment apps like Venmo to make purchases. Most credit card processors allow merchants to accept this type of payment through their credit card processing system along with traditional credit cards.

Credit card use is widespread; 70% of Americans have at least one credit card. If your customer has a card and wants to use it to buy something from you, being able to accept that card enables you to make that sale. Since paying with a credit card is convenient for consumers, they often use them for impulse purchases, and they also buy more when paying by card, boosting your overall sales revenue. For online sales, accepting credit cards is even more critical, since 9 in 10 e-commerce sales are made via credit card. 

Credit card processing hardware and software

At a minimum, you need specialized software to process credit card transactions. The credit card processor will provide you with this software. If you accept credit cards in person, you will also need credit card processing hardware, which the credit card processor usually sells. The type of software and hardware you need depends on how you do business.

Credit card software

The most basic software is the kind provided with a payment gateway for strictly online transactions. It is web based and has a dashboard to display all of your transactions. You will be able to search for specific transactions and use the data to create sales reports. You can also go into individual transactions to carry out refunds or take other actions.

More sophisticated credit card processing software, like that provided by major credit card processors, includes more reporting capability, the ability to account for promotions and discounts, adding subscription or membership recurring purchases, and appointment scheduling. This software is typically compatible with mobile phones, tablets, computers and POS hardware.

The software with the most functionality is POS software, which is often used with POS hardware. In addition to the above features, it also lists each product or service with details, keeps track of product inventory, accounts for multiple locations, and has a more intuitive interface to make in-person checkout faster and more efficient. Some credit card processors also provide industry-specific POS, such as one for restaurants that allows them to coordinate between servers and the kitchen, provide seating plans, and fulfill other restaurant-related needs. 

Credit card processing hardware

For strictly e-commerce transactions, no credit card processing hardware is necessary. Your e-commerce website will connect to the payment gateway through its code. You can forgo credit card hardware if you accept card payments primarily by phone, by mail, and only occasionally in person by manually entering the customer’s card information into your gateway.

However, if you have a significant number of in-person transactions, you will benefit from hardware. First of all, card-present (swiped, inserted or tapped) transactions incur lower processing rates. In addition, manually entering cardholder data makes checkout slow, inconvenient, inefficient and prone to errors. There are a few kinds of hardware available:

• Wired card reader: These card readers are hardwired to cash registers or POS hardware. Some of them accept only swiped (magnetic stripe) and inserted (chip) cards, while others also accept contactless NFC, or tapped cards. Some readers also allow purchasers to input their PIN for debit cards.
• Mobile card readers: These are the same as wired readers, but they connect to mobile devices, either by plugging into them or via Bluetooth. This allows the merchant to make sales on the go.
• POS hardware: This is typically a tablet or similar device that allows the cashier to display and select product and customer information. Some of them have built-in card readers, and others connect to an external card reader. 
• Accessories: These depend on your needs. Accessories include a stand for the POS hardware (although some have an integrated stand), receipt printers, cash drawers and chargers for mobile card readers.

Types of credit card processing companies

Both credit card processors and credit card facilitators can process credit card transactions. Credit card processors and facilitators offer many of the same services, but there are some key differences.

Credit card processors

Payment processors handle the flow of transaction information from consumer to merchant through the card networks to the issuing bank, and eventually back to the merchant’s bank. They set up a merchant account for each merchant, provide software, provide PCI compliance (included or for an extra fee), and sell credit card hardware to merchants. Merchants apply for an account with them, and may be approved or denied based on criteria like their business size, monthly transaction volume, processing history, or type of business. Payment processors may have cheaper rates, especially if a merchant only decides to accept lower rate card brands. For example, a merchant may decide to keep costs down by not accepting American Express, which has higher rates than Visa, Discover or Mastercard. Stax and Merchant One are examples of credit card processors. 

Credit card facilitators

Credit card facilitators have one master merchant account. Each merchant is treated as a submerchant under that umbrella. The facilitator contracts with a credit card processor, who processes the transactions for all of the submerchants. Credit card facilitators charge one flat rate for all credit card transactions, regardless of the credit card brand. So, a transaction paid for with a Visa is charged the same rate as one paid for with an American Express. Debit cards are charged a slightly lower rate. Credit card facilitators often provide a variety of services at once, making them a one-stop shop. They also approve nearly every type of business, regardless of size, history, or volume, so they are a great choice for startups and other very small or new businesses. PayPal and Stripe are credit card facilitators.

How to choose a credit card processor

The best credit card processor for your business depends on several variables. Overall, look for competitive rates and fees; knowledgeable and available customer service; fast, secure, and reliable hardware; and easy-to-use software that meets your business needs. Aside from these factors, consider the following when choosing a credit card processor:

• How and where you plan on accepting credit cards: Will you be making e-commerce sales only, fixed in-person sales, mobile in-person sales, or a combination of all three? 
• Monthly volume: Some processors give lower rates to high-volume merchants, which can be good or bad for you, depending on your current sales volume. Some charge merchants a fee when their transaction volume falls below a certain threshold.
• Your business’s size and history: Some processors are more willing than others to take on new or smaller merchants. 
• Your industry: Some processors are reluctant to approve merchants in certain industries that are considered high risk, such as CBD stores, credit repair, and online gambling, while others do not have a problem with these types of companies.

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