How credit card processing works

Credit card processing involves several steps that happen quickly, often in less than a second at the point of sale. Here is a breakdown of how it works:

1. Authorization

When a customer makes a purchase using their credit card, the first step is authorization. The merchant sends the transaction details (amount, card number, expiration date, etc.) to a payment processor, who relays this information to the respective card networks (such as Visa or MasterCard).

If the transaction is valid, the issuing bank approves the transaction and places a hold on the customer’s funds. This step is crucial because it ensures that the customer has sufficient funds to make the purchase.

2. Settlement

After the transaction is authorized, the next step is settlement. This occurs at the end of the business day or at a preset time. During settlement, the merchant submits the batch of authorized transactions to their payment processor for final approval and fund disbursement.

The payment processor then communicates with the card networks and the banks to transfer the funds from the customer’s bank to the merchant’s bank account. This typically takes one to two business days.

3. Fees

Credit card processing is not free. Various fees are associated with each transaction, including:

• Transaction fees: A percentage of each transaction, charged by the payment processor.
• Service fees: Monthly or annual fees charged by payment processors for their services.
• Chargeback fees: Fees incurred if a customer disputes a transaction.

These fees vary based on the merchant’s agreement with their payment processor, so they should be carefully reviewed before selecting a provider.

4. Gateways

Payment gateways are the technology that enables credit card processing. They serve as the bridge between the merchant’s eCommerce platform (website) and the payment processor.

When a customer enters their card information on the merchant’s site, the payment gateway encrypts the information, ensuring it is securely transmitted to the payment processor without falling into the wrong hands.

5. Chargebacks

A chargeback occurs when a customer disputes a transaction and requests their bank or card issuer to reverse the charge. Chargebacks can lead to fees for merchants, and excessive chargebacks can hurt their reputation and ability to process payments.

6. Underwriting

For high-risk merchants, the credit card processing application may undergo additional scrutiny. This process is called underwriting, and it helps assess the risk associated with the business. Underwriting involves evaluating the merchant’s credit history, business model, transaction history, and potential chargeback risk. A successful underwriting process often results in better rates and services for the merchant.