Credit Card Processing: What Is It and How Does it Work?

By Anna Davies · April 12, 2022 · 6 minute read

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Credit Card Processing: What Is It and How Does it Work?

When you swipe, tap, or insert your card to pay for a purchase, credit card payment processing is set into motion to authorize the transaction. On the surface, credit card processing may seem instantaneous, but in reality, it’s a complex, multi-step process. It also can be expensive for a merchant, which is why some may have a minimum requirement for a credit card payment.

Read on to learn about what credit card processing is and how it works.

What Is Credit Card Processing?

Credit card processing refers to the series of operations that occur in order for a charge to get authorized and a merchant to be paid when a consumer pays with a credit card. It is an integral part of how credit cards work to make payments.

While the process is only seconds long, it involves multiple steps and entities as well as fees. The costs associated with credit card processing are incurred by the merchant, but they can be passed along to consumers through credit card surcharges or a slightly higher price of goods (both of which are important to be aware of if you’re old enough to get a credit card).

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Stages of Credit Card Processing

The time between tapping your credit card and being asked if you’d like a copy of your receipt are action-packed. While the steps may not impact you directly as a consumer, being familiar with them can help you understand what happens if a payment is declined or you’re prompted to re-enter your information and have a generally better grasp of what a credit card is.

Payment Authorization

When a credit card is tapped or swiped, authorization occurs. The merchant collects the payment information, such as the CVV number on a credit card.

This information is then sent to the credit card processor, who then sends it to the card network. From there, the information is passed to the issuing bank, which confirms the consumer has the funds or credit to complete the transaction.

Sometimes, a merchant may conduct a pre-authorization. This is common at hotels, where a small amount is charged and held. It may also occur at gas stations.

At this point, the merchant still does not actually have the money. An authorization functions as an IOU, confirming to the credit card company and the merchant that your credit line can cover the charge. (This is another reason it can be beneficial to pay more than your credit card minimum payment each month, as it will free up more of your available credit.)

Payment Settlement

Settlement occurs when money transfers from the issuing bank to the merchant bank through the card network, and the funds are then deposited into the merchant’s account. This process generally takes several days from the point of sale.

The amount deposited into the merchant account is minus any fees that are deducted from the merchant’s payments. Fees may get deducted once a month for all activity that’s taken place during the previous cycle, or the merchant may opt to have them deducted every time settlement occurs.

From the cardholder’s perspective, this is the point in the process when a charge on their credit card account may move from “pending” to “posted.”

Recommended: What is a Credit Card CVV Number?

Who Are the Players in Credit Card Processing?

Credit card processing depends on a chain of connections. Here’s who’s doing what when it comes to credit card processing.

The Cardholder

When you choose to pay with a card, you set off credit card payment processing. Because different cards charge merchants varying fees, you may find that not all merchants take all cards. This could be a consideration when you apply for a credit card, if you know there’s a card that is frequently not accepted.

The Merchant

The merchant accepts credit card payments in exchange for the goods or services they provide. They have control over which processing system they use. Often, a processing system is combined with a point of sale (POS) system — the actual mechanism by which a person enters their payment information.

The Merchant Bank

The merchant bank, also known as the acquiring bank, is responsible for sending the card and transaction information to the credit card network. Upon approval, funds are deposited into the merchant account, minus any processing fees. The merchant bank may also provide equipment for credit card transactions, such as card readers.

The Issuing Bank

The issuing bank is the bank attached to the cardholder’s credit card. It authorizes the card information, pays the merchant bank, and charges the cardholder for the purchase. The issuing bank may also attach fees, including international transaction fees, to the purchase.

The Payment Processor

The payment processor is the vendor that facilitates communication between the merchant bank and the issuing bank, and essentially all of the processes that have to occur between a card being swiped and a payment being deposited into a merchant’s account. The processor will charge a fee for this service.

The Card Association

A card association is the card brand on the credit card, such as Visa, Mastercard, Discover, and American Express. While a credit card is attached to a specific bank, it also has a specific brand.

The card association collaborates with card issuers, merchants, and processors to help facilitate transactions. It will also receive part of the fee for a credit card transaction, called an interchange fee.

Charges Associated With Credit Card Processing

Just like consumers have to worry about APR on a credit card, merchants have to consider charges associated with credit card processing. Many merchants bake the cost of card processing into their payment structure.

Payment Processing Fees

The processing fee for a credit card transaction goes to the processor, which is the company that is responsible for accepting the credit card payment and sending the information to the payment network.

Interchange Fees

Interchange fees go to the issuing bank. These fees are generally a percentage of the transaction, plus a standard flat-fee per transaction. The amount of interchange fees can vary depending on the type of card used, whether the transaction was completed in-person or online, the amount of the transaction, and the type of business the merchant is.

Service Fees

Also known as an assessment fee, a service fee is a monthly fee that is charged by the payment network. The amount of this fee can depend on the merchant’s transaction volume as well as their calculated risk level.

Types of Credit Card Processing Models

Beyond the various fee types, there are different types of pricing models that a credit card processing company may offer. While this won’t matter much on the consumer side, a business should consider which pricing model might work best. The options generally aren’t as straightforward to evaluate as identifying a good APR for a credit card.

Flat Rate

With this credit card processing model, the processor charges a fixed fee for all credit and debit card transactions. This rate will include interchange fees. While this model keeps things simple, as you’ll know as a business owner how much you’ll pay, credit card fees can be higher under the flat rate model.

Tiered

In a tiered model, the fee charged per credit or debit card transaction will depend on its classification. Often, this processing model will have the following tiers: qualified, mid-qualified, and non-qualified, with qualified having the lowest fees and non-qualified having the highest. Because of all the nuances, this model can be complex and confusing for merchants.

Interchange Plus

This is the most common credit card processing model for pricing. With this model, all of your fees are kept separate, making this a transparent and often cost-effective method. The merchant is charged a percentage of the transaction plus a fixed fee per transaction, with the wholesale fee and the markup fee clearly distinguished.

Subscription

You’ll sign up for a membership for the subscription pricing model, which charges a flat monthly fee. Merchants will also pay a low per-transaction fee, as well as a very small payment processor fee. Monthly fees tend to be more than the transaction fees in this model, making it most suitable for businesses with high sales volumes.

Selecting a Credit Card Processor

Picking a credit card processor is an important choice for a business, and one that should involve an assessment of what your business needs and what different processors offer.

Just as you’d consider average credit card interest rates if you were choosing a credit card, you’ll want to consider the fees different processors charge. Also look at what the fee model is, as different models may be more beneficial to different types of businesses. Also consider what cards the processor will allow you to accept.

Beyond cost and accessibility, also look into the processor’s reliability and customer service availability. You might also think about additional features that are offered, such as a bundled or integrated point-of-sale system or a guarantee of next-day funds.

The Takeaway

Understanding credit card processing is helpful even if you’re not a merchant or entrepreneur. It can give you insight into why some merchants may give cash discounts, for instance, once you know the costs of card processing.

However, there are benefits to cardholders for using cards to complete their purchases, such as rewards and protections. The SoFi Credit Card, for instance, offers 2% unlimited cash back when you redeem it to save 1, invest, or pay down an eligible SoFi loan. Plus, you have the option to redeem points straight into crypto.

FAQ

How much does credit card processing cost?

On average, credit card processing can cost anywhere from 1.5% to 3%. The exact cost will depend on a number of factors, however, including the banks, the credit card network, and the payment processor. Merchants’ costs can also depend on the credit card processing model they choose.

Is credit card processing secure?

Yes, it is generally secure. Credit card processing security has come a long way, with innovations on both the processing end as well as the credit card companies that create systems for security, whether people buy in-store or online.

Can I lower my credit card processing fees?

Yes, there are a number of ways you can explore to lower your credit card processing fees. Comparing processors can be one way to secure lower fees. You might also apply a surcharge to pass on costs to customers. Or, you could simply ask your current processor if there’s any room to negotiate fees.


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