Credit Card Processing: A Complete Guide on What It Is & How It Works

Introduction 

In today’s digital economy, consumers depend on credit and debit cards, necessitating businesses to provide convenient payment options.

Credit card processing is vital for businesses to accept electronic payments securely and efficiently. Understanding this process is critical for optimizing payment systems and enhancing customer satisfaction. However, the process involves multiple stakeholders and fees behind the scenes.

Whether you operate a small business or a large enterprise, grasping the fundamentals of credit card processing enables you to navigate more effectively, manage expenses, and deliver superior payment experiences to your customers.

What Is Credit Card Processing?

Credit card processing refers to the handling of transactions made with credit cards such as verifying details, ensuring funds, and transferring money securely from customers to merchants. It enables businesses to accept credit card payments for goods or services, facilitating convenient transactions.

How Does Credit Card Processing Work?

Here’s how credit card processing works:

Initiation: The cardholder provides their credit card information to the merchant, either by swiping, inserting, or tapping the card at a point-of-sale (POS) system or by entering the card details manually for an online transaction.

Data transmission: The merchant’s POS system or payment gateway captures the transaction details and securely transmits this information to the credit card processor.

Authorization request: The credit card processor forwards the transaction data to the appropriate card network (e.g., Visa, Mastercard), which then routes the authorization request to the issuing bank.

Approval or decline: The issuing bank verifies the cardholder’s account, checking for sufficient funds and potential fraud or security issues. The bank then approves or declines the transaction and communicates the decision back through the card network to the credit card processor.

Authorization response: The credit card processor sends the authorization response – either an approval or a decline code – to the merchant’s POS system. If approved, the merchant can complete the sale.

Settlement: At the end of the day, the merchant submits the batch of approved transactions to the credit card processor for settlement. The processor forwards the transaction details to the respective card networks.

Funds transfer: The card networks coordinate with the issuing banks to transfer the funds for each transaction to the acquiring bank, which then deposits the funds into the merchant’s bank account.

The key parties involved are the cardholder, merchant, credit card processor, card networks, issuing bank, and acquiring bank.

What Are the Key Parties/Components of Credit Card Processing?

Here’re the key components of credit card processing:

• Customer (Cardholder): A customer obtains from the issuing bank a credit or debit card and uses the account to pay for goods or services. So, they can also be termed as the cardholder in this process. 
• Merchant: A merchant is any type of business that accepts card payments in exchange for goods or services.
• Payment Processors: Companies that handle credit and debit card transactions are payment processors. Payment processors connect merchants, merchant banks, card networks and others to make card payments possible.
• Credit Card Associations: These are the credit card companies like Visa, Mastercard, and American Express that create credit cards. Often referred to as credit card networks, they set all the rules, determine a fair processing rate for each sector, maintain hardware and software security and encryption, how and when to advertise to consumers, and so on. 
• Credit Card Issuing Banks (Cardholder’s Bank) : These are financial institutions that issue credit cards to customers, such as Chase, Citi, and Wells Fargo. Some card organizations, such as Discover and American Express, also assume the role of an issuing bank, creating their own cards and issuing them. Issuing banks are those that evaluate the creditworthiness of a consumer before deciding whether to issue a card to a consumer. 
• Credit Card Acquirers (Merchant’s Bank) : They are often known as acquiring banks, but in the conventional context they don’t all have to be a bank; they may be financial institutions with bank-like features. They set up a merchant, a specialized bank account used exclusively to collect card payments from issuing banks, with a merchant account. 
• Credit Card Processors: They are the one-stop-shop companies that a retailer works with to set up card payment processing. Merchants might directly deal with them or could partner with one of their resellers. Processors set up payment processing for merchants, helping them get a merchant account and ensuring that they have the proper payment card hardware and applications.

What Is a Credit Card Payment processor?

A credit card payment processor facilitates transactions by securely transmitting transaction details from businesses to credit card networks for approval and settlement. These processors enable smooth and secure credit card payments, ensuring seamless transactions between merchants and customers.

What Are Credit Card Processing Fees?

A credit card processing fee is the charge a business must pay whenever it accepts a credit card payment. There are three main types of fees associated with each transaction, and they can vary depending on the type of credit card accepted.

Interchange fees: This fee, which can also be referred to as a swipe fee or a discount rate, is paid by businesses directly to the credit card issuer. This fee may be higher for online purchases to account for the increased risk of fraud when a credit card isn’t present for a transaction. Also, note that interchange fees can depend on the type of card, how much is being charged, and the type of business being operated.

Payment processor fees: It’s also possible the payment processor will charge an additional fee to facilitate the payment. Payment processor fees can be broken down into smaller fees that take place over time and may include monthly or annual account fees, equipment rental fees, withdrawal fees, statement fees and others.

Assessment fees: Assessment fees are paid to the credit card network for the purchase to take place. Note that assessment fees are paid based on total monthly sales instead of a per-transaction basis.

What Are Credit Card Pricing Models?

Understanding the various pricing models used in payment processing can significantly impact your business’s financial efficiency. By choosing the right model, businesses can effectively manage costs associated with merchant accounts. Here are the key pricing models commonly used in the payment processing industry:

Interchange Pricing:

Interchange fees are paid or collected by the card-issuing banks that provide Visa, MasterCard, Discover, and American Express cards. These cards are commonly consumer credit or debit cards but can also be corporate, business, purchasing, or rewards cards. Interchange fees typically consist of a percentage of each transaction accompanied by a flat per transaction fee. The exact cost per transaction depends mainly on the type of card and how it’s processed.

Tiered Pricing:

This type of pricing model comes with different pricing for transactions in different tiers or buckets. For example, certain qualified transactions may be charged a lower rate, whereas others require higher fees. This type of pricing typically works best for merchants who process most of their transactions in the lowest tier.

Flat Rate Pricing:

Flat rate pricing works exactly as it sounds. With this pricing model, the credit card processor will charge the merchant a fixed percentage of each transaction plus a small per-transaction fee (usually $0.20 to $0.30 per transaction). This pricing model makes it easy for merchants to anticipate their credit card processing costs over time.

Billback Pricing:

Billback pricing or Enhanced Recovery Reduced Percent (ERR) is a mix of Interchange Cost Plus and Tiered Pricing.The merchant is charged a flat discount rate like they would if they were on Interchange, but then, at the end of the month, they are charged the ERR rate, which depends on how the transaction qualifies.

10 Best Practices of Credit Card Processing

1. Use EMV Chip Technology: Install EMV chip-enabled terminals to enhance security by encrypting transaction data, reducing the risk of fraud compared to magnetic stripe cards.
2. Adopt Tokenization: Replace sensitive card information with a unique token during transactions to minimize data breach risks and safeguard stored customer data.
3. Enable Point-to-Point Encryption (P2PE): Encrypt card data from swipe to processor to maintain secure transmission, lowering PCI DSS compliance requirements.
4. Comply with PCI DSS Standards: Follow Payment Card Industry Data Security Standard (PCI DSS) requirements rigorously to protect cardholder data. Regularly update security measures to prevent breaches.
5. Implement Address Verification System (AVS): Verify cardholder addresses for online transactions to add a layer of security and reduce fraudulent activities.
6. Monitor for Suspicious Activity: Utilize fraud detection tools to promptly identify and respond to unusual transactions. Set alerts for high-risk payment patterns.
7. Educate Employees: Train staff on secure handling of card data and recognizing potential fraud. Promote a culture of compliance and vigilance.
8. Secure Payment Gateway: Use a reputable gateway provider to ensure encrypted transaction data transmission and compliance with industry standards.
9. Regular Security Updates and Patch Management: Keep payment systems updated with the latest security patches. Regularly review and strengthen security protocols against evolving threats.
10. Monitor and Audit: Conduct routine audits of payment processes and security measures. Monitor transaction logs and review access controls to address vulnerabilities proactively.

Following these practices enhances credit card transaction security, ensures compliance with regulations, and protects customer data and business reputation. They mitigate risks associated with fraud and data breaches, fostering customer trust in the security of their financial information.

How to Choose a Credit Card Processor?

Choosing the right credit card processor is crucial for businesses to ensure smooth transactions, security, and cost-effectiveness. Let’s explore the different factors to consider when choosing a credit card processor:

1. Evaluate Business Needs: Start by assessing your business’s specific needs. Consider factors such as transaction volume, types of payments accepted (online, in-store, mobile), and average transaction size. Determine if you need additional features like recurring billing or international payment capabilities.
2. Compare Fees and Pricing Structures: Understand the fee structure offered by each processor. This includes transaction fees (flat rate or percentage of transaction), interchange fees (charged by card networks), monthly fees, setup fees, and any additional charges for services like chargebacks or PCI compliance. Compare these costs across processors to find the most cost-effective option for your business.
3. Check Contract Terms and Flexibility: Review contract terms carefully, especially regarding cancellation fees, contract length, and any automatic renewal clauses. Look for processors that offer flexibility and transparent terms, allowing you to adjust services as your business needs evolve.
4. Consider Security Features: Ensure the processor prioritizes security. Look for features like tokenization and point-to-point encryption (P2PE) to protect customer data during transactions. Verify compliance with Payment Card Industry Data Security Standard (PCI DSS) requirements.
5. Integration and Compatibility: If you use specific software or have an existing POS system, ensure the processor integrates seamlessly with your current setup. Check compatibility with e-commerce platforms, accounting software, and mobile payment solutions if needed.
6. Customer Support and Service: Evaluate the quality of customer support offered by the processor. Consider factors like support availability (24/7 vs. business hours), responsiveness, and ease of reaching support staff. Reliable customer service ensures quick resolution of issues that may arise.
7. Read Reviews and References: Research customer reviews, testimonials, and references from businesses similar to yours. This provides insights into the processor’s reliability, customer satisfaction, and overall performance.
8. Scalability and Growth: Choose a processor that can scale with your business as it grows. Consider whether it offers additional services or support for expanding into new markets or handling increased transaction volumes.

By carefully considering these factors and conducting thorough research, businesses can choose a credit card processor that meets their operational needs, enhances payment security, and supports their growth and customer service goals effectively.

How HighRadius Can Help Businesses Optimize Credit Card Costs Through Strategic Surcharge Management

HighRadius offers a strong B2B surcharge management software can benefit businesses particularly concerning credit card transactions. By implementing effective surcharge management systems, businesses can offset the costs associated with credit card processing fees. This approach allows them to recover a portion of these expenses, thereby preserving profit margins that might otherwise be eroded by high transaction fees.

Strategically applying surcharges on credit card transactions ensures that businesses remain competitive in pricing while still offering the convenience of credit card payments to customers. Moreover, it helps businesses comply with regulations and card network rules regarding surcharging, ensuring legal adherence and avoiding potential penalties.

Besides, surcharge management for credit cards enhances transparency in pricing for customers. Clearly communicating surcharge policies upfront builds trust and reduces the likelihood of customer disputes over unexpected fees. This transparency is crucial for maintaining positive customer relationships and enhancing overall satisfaction.

Integrating effective surcharge management for credit cards into B2B payment strategies not only helps businesses manage costs and maintain profitability but also promotes fairness and transparency in pricing practices. It represents a strategic approach to optimizing financial operations and supporting sustainable business growth in a competitive market environment.

FAQs

1) What does processing mean on credit cards?

When a customer submits their credit card information, it’s sent to the processing network, which verifies with the bank for available credit. Anti-fraud measures are applied; if no issues arise, the transaction proceeds. The processor handles the transaction, paying interchange fees and retaining processing charges before releasing funds to the merchant’s account.

2) What is the average fee for credit card processing?

Businesses are charged fees when customers use credit cards for transactions. These fees vary based on the type of credit card accepted and can include multiple charges. On average, credit card processing fees range from 1.5% to 3.5% per transaction, impacted by factors such as interchange fees.

3) What does payment processing mean?

Payment processing involves verifying and approving transactions and then automating fund transfers to merchants and relevant parties. Utilizing advanced hardware and software, it ensures credit card transactions are processed, validated, and either approved or declined efficiently.

4) What is the credit card processing level?

Credit card processing levels refer to categories that determine the interchange fees charged for transactions based on the type of information provided during processing. Levels vary from basic data entry (Level 1) to more detailed information for lower fees (Level 3), commonly used in B2B transactions.

5) What are the methods for processing credit cards?

Credit cards are processed through various methods, including:

• Card-present transactions: Where the physical card is swiped or inserted into a POS terminal.
• Card-not-present transactions: Such as online payments where card details are entered manually.
• Mobile payments: Using smartphones or tablets with NFC technology.

6) How long does a payment on a credit card take to process?

The processing time for a credit card payment typically ranges from immediately to a few business days, depending on factors like the issuer’s policies, the payment method used, and the time of submission relative to the card’s billing cycle.