How Credit Card Transaction Processing Works

December 29, 2021

Each business day, 108 million credit card payments process nationwide, making up 38% of all transactions. If you have an online business, your percentage is most likely higher. You make more money by honoring credit cards than if you don’t. And with the benefit of instant credit for purchasing, these cards lead to higher per-order transactions, helping to compensate for credit card processing fees.

With the continued high demand for credit card purchasing from customers and merchants, today’s technology for merchant service providers makes it even easier for businesses to connect to merchant banks and credit card networks via touchless chip cards and mobile payment systems.

As a small business owner, you may wonder how credit card purchases are processed. What exactly goes into the transaction process? This article lays out each entity and each step in the process.

Understanding Credit Card Processing: How Credit Card Transaction Processing Works

Every time a customer swipes a credit card, several behind-the-scenes actions occur within seconds. Processing involves several parties: the cardholder, the merchant, the acquiring bank, the issuing bank, and the card network. Each party connects in coordinated steps, and the processing is complete the moment the transaction reads approved or declined.

A Step-by-Step Guide to How Credit Card Processing Works 

The entire process for credit card processing is a multi-step process between numerous entities. Still, approval for a customer order happens in a matter of seconds. All in all, the entire settlement process takes a few days. 

These are the stages and key parties involved in credit card processing:  

Stage 1: It All Starts with the Cardholder

A cardholder is an individual or business with whom the credit card is connected. The individual or business name shows on the card. 

Today, cardholder purchases are made through stationary or mobile payment terminals or online systems for added convenience to cardholders. Still, just as it has been since cards were first offered, the cardholder is expected to place the orders personally and is even required to show ID when buying in person. The credit card companies maintain contracts with cardholders under their name. 

Customers Place Orders with Merchants via a Credit Card Machine or Credit Card Software 

What are the methods for processing credit cards 

Today’s technologies help merchants place orders anywhere they and their customers are located to improve the customer experience. Orders can be placed on terminals by brick-and-mortar merchants using a credit card reader or any number of touchless chip card systems. Cards can also run through a mobile device, online on the merchant website or through an eCommerce merchant site. 

These systems connect to merchant account software for immediate readings on payments, stock changes, and customer histories. A merchant services provider can help set up needed hardware and software and even aid in setting up merchant accounts at merchant banks.  

Payment Goes Through a Payments Gateway

When a customer places an order, the credit card terminal dials up a connection to the credit card gateway. This secure remote computer server lets credit card terminals log on and start a credit card transaction session with the credit card issuer.

The Payment Request is Sent to Your Credit Card Processing Company or Cardholder Bank

With the help of the gateway, the payment request is received by an acquiring bank or a payment processor. 

payment processor is an institution in charge of sending the payment request and feedback to the credit card network and your payment terminal. Any approvals or denial information is a direct result of the payment processor.  

An acquiring bank is a bank that houses your merchant bank account, which is the account used for sending and receiving credit card payments to your business bank account. This account also handles any customer service-related issues regarding card acceptance. In some cases, the acquiring bank acts as the processor. 

Merchants must have an acquiring bank account to receive credit card funds—it can be a bank account at the merchant’s business bank, another bank, or a third-party merchant account 

Communication is Sent to the Card Associations (such as Visa or MasterCard)

The processor (or acquiring bank acting as the processor) sends the fund request to the credit card association, which forwards the request to the credit card’s bank to authorize payment. 

Card Associations (Visa, MasterCard, American Express, Discover) are electronic networks/clearinghouses in charge of communicating between the merchant and credit card banks. It also has other functions like maintaining the networks and offering guidelines for customersmerchants, and financial institutions. They also handle arbitration and overall governance and oversee interchange fees, channel requests, denials, and funds between the banks. In short, each network is an electronic highway used to connect banks and approve or deny funds transfers. 

When the card association receives the communication request from a processor, it forwards it to the issuing bank. What is an issuing bank? 

The Issuing Bank Checks Credit Limits, Funds, and Account Standing 

The issuing bank is not the customer’s personal bank account; rather, it’s the bank that offers credit for the funds. The bank entity, also called the credit card company, is indicated on the card.  

This point in the buying process is the authorization stage. The issuing bank checks that the customer’s account is in good standing, that they have sufficient funds for the purchase and won’t exceed the credit limit, and that payments to the account are current. If all is approved, the bank sends back an approval code through the card association network to the processor and the terminal, stating approval for electronic fund transfers. The same process follows for denials.    

The Credit Card Clearing Stage/Settlement Stage

With an approval code from the processor and a signature from the customer (if a purchase is made in person), the customer’s role in the transaction is complete. All that’s left is for the merchant to settle the payment. At this stage, the merchant sends a “batch” request to the processor. A batch isn’t just one charge, but a group or “batch” of credit card approvals. Typically, a merchant sends one batch per day. Batches can be sent more often, but merchants are charged for each batch submission. 

The processor reconciles the authorizations, sends each batch through the card association networks, and deposits the funds into the acquiring account minus the processing fees of the processor and the card association. The funds are then moved from the acquiring bank and into the merchant business account. Behind the scenes, the issuing bank deposits funds into the cardholder bank. The total movement and authentication stage takes a few days. 

Credit Card Fees: How Much Does Credit Card Processing Cost? 

The fees that merchants pay are a blend of interchange fees from the card issuer (the card’s bank) and credit card processing fees—a markup over interchange fees by the acquiring bank and payment processor. The total price varies based on the association network, the type of card, and the merchant code of the business corresponding to the type of goods and services the business offers. 

Other cost factors come into play as well for business owners. The processing method determines the interchange fee. For instance, an online transaction is more expensive than an in-person transaction due to increased risk. Other fees include late fees, annual membership fees, cash advance fees, and returned payment fees. It’s’ important to note that merchants, as well as customers, can be charged for a customer’s insufficient funds. 

Each entity in the payment process typically charges a percentage per transaction plus a flat fee. When factoring in all interchange rates and processing rates, the percentage ranges from 2.8% to 4.3%.   

How to Set Up Credit Card Processing through a Merchant Services Provider

Credit card processing doesn’t have to be complicated. Work with a partner, like BNG Payments, who will guide you through the process. Don’t be afraid to shop around, especially when considering a merchant services provider. Keep a sharp eye on the contracts. Some providers organize fees in ways that benefit them most in the end.  

BNG Payments offers competitive rates, clear and understandable contracts and excellent, U.S.-based customer service. Contact us to get started


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