Credit Card Processing: How It Works and What You Need to Know

Many consumers now rely on credit cards for their purchases, considering it a convenient payment option.

However, the majority of customers and business owners are not familiar with the intricacies of credit card processing.

This process can be quite complex, involving unfamiliar industry terminology, the coordination of various participants, and the need to acquire a card-reading device.

A significant portion of the credit card processing process occurs without the knowledge of business owners.

Although it is beneficial to have a comprehensive understanding of the entire process and the key participants involved, it is crucial for business owners to focus on comprehending the necessary hardware and software for credit card processing, as well as the associated fees.

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What is credit card processing?

The process of credit card transactions involves various components. One aspect includes the customer and the bank responsible for issuing their credit card. On the other side, there is the merchant and the bank that will ultimately receive the payment.

To facilitate this exchange, information regarding the transaction is transmitted between the two banks via a credit card network. Additionally, a payment processor is involved to ensure the seamless operation of the transaction.

How does credit card processing work?

The process of credit card processing can be divided into two main steps: authorization and settlement. During the authorization step, which usually takes only a few seconds, the card is either approved or declined.

However, the settlement stage holds equal significance for the merchant as it involves receiving the actual funds.

Authorization

When a customer wants to make a purchase using their credit card, they will input their card details into the merchant’s card-reading device. This information is then transmitted to either the merchant bank or payment processor.

From there, the information is sent through the appropriate card network to the bank that issued the card.

The issuing bank verifies the card details, checks the account status and available credit of the cardholder, and then sends an approval or denial response to the merchant bank. Finally, the merchant bank or payment processor relays this decision back to the merchant’s card reader.

When it comes to online and e-commerce card transactions, the process of authorization may vary and might necessitate the use of both a payment gateway and a payment processor.

Settlement

During the process of settling transactions, the funds are transferred from the bank that issued the credit card to the merchant’s account. Typically, merchants send a group of authorized credit card transactions to their payment processor or merchant bank at the end of their business day or at a predetermined time.

These transactions are then directed to the card networks, which collaborate with the issuing and merchant banks to ensure that the funds are correctly deposited into the designated merchant account.

During the settlement process of credit card processing, the issuing bank subtracts interchange fees from the transaction amounts before transferring the funds to the merchant account. Typically, it takes approximately one to three business days for this process to be finalized.

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What’s needed to process credit cards?

In order to process a credit card transaction, a business owner usually requires both hardware and software to collect the necessary information.

Hardware

Credit card processing hardware can range from a basic card reader that connects to a smartphone to more advanced devices like terminals, registers, or complete point-of-sale (POS) systems.

These devices gather card information and send it to the merchant’s payment processor via the internet or phone line. Payment processors usually provide various hardware choices for merchants.

Software

When it comes to handling credit card payments, it is common for businesses to rely on payment apps. While some of these apps come for free when purchasing the necessary hardware, others may have a monthly fee.

These software programs are equipped with various functionalities like inventory management, customer tracking, email receipt sending capability, and reporting and analytics.

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How much are credit card processing fees?

Apart from the expenses related to the hardware and software, merchants are also required to pay fees for credit card processing. Typically, these fees amount to around 1.5% to 3.5% of the total transaction value and consist of three distinct charges:

Interchange 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.

Businesses may incur extra charges depending on the payment processor they opt for and the services they require. For instance, certain payment processors may impose a fee for PCI compliance, whereas others may not.

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How Secure Is Credit Card Processing?

When it comes to processing credit card payments, there are inherent risks involved. Experiencing a data breach can result in significant financial and personal consequences for both you and your customers. However, there are measures you can take to protect this vital information.

For businesses that accept or handle payment cards, it is essential to comply with the Payment Card Industry Data Security Standard (PCI-DSS) set by the PCI Security Standards Organization. PCI compliance ensures that cardholder data is securely handled, transmitted, and stored by merchants and service providers during credit card transactions.

It is crucial for business owners to select a credit card processing service that meets PCI compliance requirements. Safeguarding your customers’ information is vital for the smooth operation and profitability of your business.

When a business conducts transactions in person, it is important for the owner to take into account Point of Sale (POS) systems that are compatible with EMV chip cards. These cards offer an additional level of security against fraudulent activities during in-person sales.

EMV cards are now the prevailing standard for safeguarding against fraud, and the majority of credit card processing companies are equipped to provide EMV-compatible terminals.

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Who is involved in credit card processing?

The following entities are central to how credit card processing works to securely capture payments at the point of sale (POS).

• Consumer
  • The cardholder, or the person making the purchase.
• Merchant
  • The person or business selling the product or service the consumer is purchasing.
• Payment gateway
  • Credit card processing involves the use of technology that links a merchant to a payment processor. This gateway is designed to work with both card-present transactions, such as in-store purchases, and card-not-present transactions, such as online or eCommerce payments.
  • It is responsible for collecting payment information from customers and sending it to the payment processor or merchant bank. Once the transaction is processed, the gateway sends a notification to the merchant indicating whether the payment has been approved or declined.
• Credit card processor
  • Credit card processor, also commonly referred to as a “payment processor,” is an organization that acts as a mediator between the merchant, the credit card network, and the cardholder’s bank.
• Card network
  • The term “credit card processing” is another way to describe the “credit card network” or “credit card brand.” It represents the specific brand of the customer’s credit card, like American Express, Visa, Mastercard, or Discover. The credit card networks have the responsibility of establishing interchange and assessment fees, as well as the standards for PCI DSS.
• Issuing bank
  • The issuing bank, also known as the “cardholder’s bank” or “consumer bank,” is the financial institution that issues the credit card to the customer. In the credit card processing cycle, one of the main responsibilities of the issuing bank is to verify if the cardholder’s account has enough funds to complete a transaction and to authorize the release of those funds for settlement.
• Acquiring bank
  • The acquiring bank, also known as the “merchant bank,” is the financial institution utilized by merchants to store their business funds and receive payments from transactions. In addition to offering card readers and equipment for accepting card payments, the acquiring bank can also function as a credit card processor.