How Payment Processing Works – Who’s Involved?

Understanding credit card processing basics allows you to make better-informed decisions about which payment solutions are best suited for your business. For example, you can avoid unnecessary add-ons and fees by designing a payment environment that only delivers the specific features you need to securely, quickly, and easily process incoming card-based sales.

In the next section, we’ll explore the details of how payment processing works. First, we need to meet the key parties that make each transaction possible:

• The cardholder is the customer who initiates an in-person or online purchase using a credit or debit card
• The card issuer is the bank that provides its customers with consumer plastic
• The merchant is the card-accepting business owner selling whatever goods or services the customer is trying to purchase
• The payment processor is responsible for securely routing the transactions captured by the merchant’s point-of-sale device to the customer’s card-issuing bank for approval
• The card association is the network maintained by the major brands (Visa, Mastercard, Discover, etc.). This card association is responsible for setting fees, resolving disputes, and establishing security guidelines for the network
• The acquiring bank is what the merchant uses to ultimately collect funds from the issuing bank. This may be the same entity as the merchant’s payment processor

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What is a Chargeback Fee?

A credit card chargeback fee occurs when a cardholder disputes a particular charge on his or her credit card statement to nullify the transaction. This means the customer is requesting the card-issuing bank to return the funds back to his or her bank account.

A chargeback fee is issued by a bank for each chargeback dispute. When a chargeback is set into motion, the customer’s card issuing bank reimburses the cardholder for the transaction amount. When the card issuer/credit card provider reimburses the cardholder, they’re basically pulling the funds from their own pocket. The card issuer will then pull the transaction amount from the merchant’s account to recover the funds they’ve lost.

3 types of chargebacks

Chargebacks can be a hassle for merchants. Thankfully, your business can mitigate and avoid these unnecessary fees and disputes altogether by learning more about the different scenarios that cause chargebacks.

Here are three types of chargebacks your business should be aware of:

1. True fraud

A true fraud chargeback occurs when a cardholder’s card or account has been compromised and used by an unauthorized party to purchase products or services without the permission of the cardholder. This results in the cardholder filing a chargeback for unauthorized use of the card or account.

2. Friendly fraud

Friendly fraud chargebacks typically occur when cardholders claim they’re unaware of purchases made using their cards or they never received a product they paid for.

Friendly fraud can also occur when cardholders claim they returned products and ask for a refund, even if they never actually returned the product. In these instances, cardholders will often file disputes directly with their credit card companies to avoid interacting with merchants.

Sometimes friendly fraud can be an honest mistake — customers sometimes input the wrong delivery address or make a purchase without fully understanding recurring billing terms. Regardless of the motive, this type of fraud can result in money loss and a damaged reputation if not addressed properly.

3. Merchant error

Unfortunately, there are also chargebacks that can result from a mistake or error on the merchant’s end.

Merchant error chargebacks can be due to a multitude of factors. Whether you accidentally charge a customer twice for an item or ship an item to the wrong address, merchants should be aware of these mistakes to avoid triggering a chargeback dispute and fee.

How do chargebacks work?

Now that we’ve explored the different scenarios that could trigger a chargeback, let’s break down how a chargeback actually works:

• The cardholder contacts his or her card issuer/credit card provider to request a chargeback on a particular transaction.
• The card-issuing bank pulls the transaction amount from the merchant’s account to credit the amount back to the cardholder’s bank account.
• The merchant’s payment processor sends an alert to notify the merchant of the chargeback.
• The merchant goes through their records to dispute or accept the chargeback.
• If the merchant is unable to procure a sufficient amount of evidence to dispute the chargeback, then the funds will not be returned to the merchant’s account.

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Who’s Involved in Credit Card Processing?

Every transaction made requires an entire chain of participants, ensuring the process is seamless. Here’s every participant involved:

• Cardholder: A customer who uses a credit or debit card at checkout.
• Credit card: A card with payment credentials used to make a purchase. Each credit card has a unique EMV chip embedded on the card, adding additional transaction security and reducing fraudulent transactions.
• Merchant: A business (like yours) that accepts credit cards as a form of payment.
• POS: The point-of-sale system used by the merchant (your business) to accept credit card payments.
• Issuing bank: Provides the customer with their credit card and an accompanying line of credit. Examples include U.S. Bank and BMO*.
• Acquiring bank: This is your credit card processor's banking relationship, which will collect the card transaction information from your POS system and route the transaction through the card network and the card issuing bank for authorization, settlement and funding to your business's depository bank.
• Card network: This is the card brand “middleman” (like Visa, Mastercard, and Discover) that manages the network to authorize, settle and eventually direct your customer's payment request to your business. It goes from your credit card processor and the acquiring bank to your customer’s card issuing bank. Then, it returns with either an approval or a decline.
• Merchant services provider: The company that may provide your business the tools and services to accept payments. They put everything in motion, so each step in the transaction process connects properly between banks, card networks, and your POS system. 
• Payment gateways: Facilitate the transfer of payment information between a payment portal, such as a business website and the credit card processor and the acquiring bank.

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How Does Card Processing Work?

There are two stages to credit and debit card processing – authorization and settlement. If a debit card is used, both authorization and settlement happen in seconds with the money coming out of your checking account. If a credit card is used for payment, the account information is routed from the merchant bank by the payment processor to the issuing bank for approval. The issuing bank will either confirm or deny the transaction and the payment processor will deliver that back to the merchant bank and to the card reader.

Unlike the near instant settlement for a debit card, a credit card settlement can take 1-3 business days. This is the process of actually moving the funds from the issuing bank to the merchant bank. Typically, businesses send batches of transactions to their payment processor at a regularly scheduled time, like the close of a business day. The payment processor and the card networks (Visa, MasterCard, etc.) will work to ensure the funds are deposited into the correct account.

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How Long Credit Card Payments Take to Reach your Bank Account

Most small businesses receive credit card payments within one to five business days, depending on the processor’s funding schedule. Some providers offer faster deposit options for an additional fee. 

Here’s what affects merchant account funding times: 

• Processor cutoff times: If your business batches credit card transactions after your processor’s daily cutoff time, settlement may not begin until the next business day.
• Weekends and bank holidays: Transactions processed outside normal banking days often settle on the next business day.
• Funding speed options: Many payment processors offer next-day or same-day funding, shortening deposit times for an extra fee.
• Bank posting schedules: Even after settlement, your bank’s internal posting times can affect when money appears in your account.
• Merchant account risk reviews: New businesses or unusual transactions may trigger temporary holds while the processor verifies activity. 

Small business credit card processing fees and pricing 

Credit card processing fees are the costs small businesses pay to accept card payments. They include transactional, flat, and incidental fees. Payment processors may charge different rates for invoicing, QR codes, and recurring transactions. 

Per-transaction rates typically range from 1.5% to 3.5%. However, costs can reach 5%, and debit card payments may cost less than credit card transactions. 

Standard transaction fees and payment processing rates

Each credit card transaction incurs standard fees. The funds are dispersed to card networks, banks, and payment processors. The three types of credit card transaction processing fees are:

• 1.) Interchange fees: Card brand networks set interchange fees. A percentage of each transaction plus a fixed fee goes to the cardholder’s issuing bank.
• 2.) Assessment fees: Card associations charge a small percentage to cover infrastructure and operating costs. These fees go to the card network (Visa, Mastercard, etc.).
• 3.) Processor markup (merchant service fees): Credit card processors and merchant service providers charge percentage, per-transaction, or monthly fees for their role in payment processing.

In addition to standard credit card transaction fees, merchants may pay for verification services or payment card industry data security standard (PCI DSS) compliance. To see what fees you currently pay or compare card processing companies, request a sample merchant statement. 

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