What is credit card processing

This is a repost from USNews.

A credit card transaction might seem as simple as a swipe, dip, or tap, but it involves multiple steps and players. Credit card processing is how businesses complete credit card and debit card transactions. Credit card processing services expedite card transactions, and payment gateways securely transmit data so money from a customer’s issuing bank can be transferred to a merchant’s account. All of this happens in seconds. The end result is a customer who successfully makes a purchase without using cash or a check—and a business that completes a sale.

What Is a Credit Card Processor?

A credit card processor is a vendor service that enables merchants and business owners to accept payments from customers who are using payment methods other than cash or check. A credit card processor navigates the interface between the merchant’s bank and the customer’s.

While sometimes confused with one another, a payment gateway and credit card processor (sometimes referred to as “payment processor”) are separate entities, though both critical to a transaction. A payment gateway moves data securely, and a credit card processor transfers funds. A credit card processor handles credit and debit card transactions for merchants, essentially acting as the mediator.

Credit card processors:

Seek approval for a transaction
Communicate with the cardholder’s issuing bank
Transfer funds into a merchant account.

There are different types of credit card processing services that businesses can opt for, and it is important to understand the differences in order to find the most cost-effective model, especially for small businesses:

Subscription-based credit card processing service: These typically come with a monthly fee and have various pricing models. Plans may include additional fees per transaction, though these are sometimes lower than other companies. Subscription plans tend to benefit merchants and businesses with high transaction volumes.
Interchange-plus credit card processing: Merchants can incur fees per credit/debit card transaction. These fees can include an interchange rate, also known as a swipe fee, that is charged by the credit card issuer. Credit card processors typically have transaction fees that are either interchange-plus or flat-rate. The interchange-plus model is where the processor charges the fixed interchange fee and an additional fee on top of that. For example, a processor might charge 1.8% of the purchase as the interchange fee and then an additional percentage or fee as well, such as 0.3% or 7 cents.
Flat-rate credit card processing: In flat-rate processing, fees are a static rate, usually above the interchange rate. A processor might charge a percentage fee based on the transaction, which would cover the expense of the interchange rate and then some.

Some processors will charge flat monthly fees for a payment gateway or merchant account that covers these essential services. Merchants may also be required to pay incidental fees for situations like a chargeback or insufficient funds. Some credit card processors also bundle services, offering a payment gateway and merchant account so you can work with a single credit card processing entity to complete transactions.

Is There a Difference Between a Credit Card Processor and a Payment Processor?

These terms are often used interchangeably. A credit card processor facilitates credit card and debit card transactions. Payment processors also handle credit card transactions and are often referred to as credit card processors. Be sure that your credit card processor and payment gateway integrate so that transactions can be processed seamlessly.

How Does Credit Card Processing Work?

On the surface, a credit card transaction seems simple, but there’s much more to it. When you use a credit or debit card to make a purchase, a series of actions occur electronically to complete the transaction. During a single card transaction, a payment is processed, verified, accepted or declined, and money is transferred. While the entire transaction may only take seconds, the process occurring behind the scenes is complex.

Here’s what happens when you make a purchase. For example, let’s consider what a payment transaction looks like when you place a simple fast food order of a burger, shake, and fries.

Step 1: Engage at the point of purchase. When you place your order, your cashier gives you your total and you present your payment method. You are at the point of purchase. This can be in-store or online. If you’re placing a delivery order, you may be keying in your information. Payment methods at a point of purchase can include a debit or credit card, cash, check, or money order. Today, even more consumers are using digital payment methods to make in-store and online purchases. According to new projections from PwC, the volume of cashless payment transactions globally is expected to increase by more than 80% between 2020 and 2025, from 1 trillion to 1.9 trillion.

Step 2: Connect to a payment gateway. A payment gateway is a tool that securely connects information that is sent through the credit card processor from a customer’s bank to the merchant’s account. Once you give your payment information for your meal, the payment gateway communicates a payment decline or acceptance. However, it’s the processor that quarterbacks the transaction by seamlessly gathering card information from the customer’s issuing bank (credit card/debit card) to transfer to the merchant account.

Step 4: Deliver information through a credit card processor. Credit card processors act as a shuttle, delivering information from the credit card customer’s issuing bank to merchant accounts, where accepted payments ultimately land.

Step 5: Confirm payment with the issuing bank. The issuing bank is a financial institution associated with a customer’s credit card. The credit card processor validates card security and facilitates the transfer of payment, moving money from the issuing bank to the merchant account.

Step 6: Transfer funds to a merchant account. When a credit card transaction is processed and approved, the credit card processing company facilitates the movement of money from the issuing bank to the merchant account. This bank account enables a business to accept credit cards, debit cards, and digital payments.

This entire process happens rapidly, between the time you place your order and the moment your receipt is handed to you or emailed to you. Before you know it, you’re sitting down to enjoy your meal.

What Is a Point-of-Sale System?

A point of sale (POS) is the core of a merchant’s payment infrastructure. POS systems include hardware and software that allow merchants to take payments, track inventory, and facilitate other business functions such as scheduling appointments or managing payroll. A point-of-sale system allows customers to select among various payment options including credit cards like Visa or American Express, a digital wallet, a debit card, an online payment, or even crypto. Ultimately, a merchant’s POS system completes sales transactions including adding in sales tax, accounting for promotions, and providing receipts.

A credit card processor is not the same as a POS system. However, some POS systems provide credit card processing and a payment gateway as a bundled service. Learn more about point-of-sale systems and how they work.

What Is a Payment Gateway?

A payment gateway establishes a secure connection to encrypt credit card data and move it safely. The payment gateway verifies a card’s authenticity while preventing a customer’s personally identifiable information from leaking during a transaction.

Here’s what the process looks like when a cardholder makes a purchase:

The transaction is initiated when the customer enters their payment information online or presents their card in store.
Data from the card enters the payment gateway and is passed to the merchant’s bank.
The credit card processor communicates with the customer’s card network (for example, American Express or Visa) to route the transaction to the issuing bank.
The issuing bank will verify funds and accept or decline the charge. This step also involves scanning for fraudulent or suspicious transactions.
A code is sent to the credit card processor once the transaction is verified by the card-issuing bank, which then transmits that code to the payment gateway.
The merchant and customer receive a payment completed message on the card reader. The whole process only takes a few seconds.

You might not need a separate payment gateway if you accept credit and debit cards through a POS system that offers this technology. For example, clover POS system captures customer data and works directly with payment gateways to route money from the issuing bank to a merchant bank.

Payment gateways are sometimes integrated with virtual credit card terminals or offered as an in-house service from a credit card processor, so merchants can work with one entity to complete cardholders’ transactions. Businesses of all sizes should consider the importance of security, the added layer of protection from a payment gateway is appealing to many businesses.

What Is a Merchant Account?

A merchant account acts as a holding area for pending cardholder transactions. After a credit or debit card payment is processed and approved, it is funneled from the card-issuing bank to a merchant account. Then, those funds are credited toward a business’s bank account.

A merchant account and business bank account function differently. A business account handles expenses related to operations, such as paying for rent. A merchant account is only for credit card processing.

In the payment processing chain, the merchant account is the landing pad for payments. After cardholder transactions are successfully processed and approved, it transfers to a merchant account. Usually, within 24 hours to three days, payments are moved from a merchant account via an ACH transfer to a business’s financial institution.

Credit card processors assign merchants an account, where funds are held. Merchant accounts can be bundled with credit card processors as an additional feature, or included with a POS system. Small businesses might choose to begin processing payments by associating with a payments aggregator (payment facilitators) like PayPal, Stripe, or Square to gain access to a master merchant account as a sub-merchant.

How Secure Is Credit Card Processing?

Accepting credit card payments is not without risk. The professional and personal costs of a data breach can be astronomical for yourself and your customers. There are, however, ways to safeguard this critical information. If your business accepts or processes payment cards of any type, you must adhere to the Payment Card Industry Data Security Standard (PCI-DSS) outlined by the PCI Security Standards Organization. PCI compliance requires a cardholder’s data to be safely processed, transmitted, and stored by merchants and service providers throughout the credit card payment process. It is important that business owners choose a credit card processor that is PCI-compliant. The security of your customers’ information is pivotal to running a successful and profitable business.

If a company processes in-person transactions, the business owner should also consider POS Systems that work with EMV chip cards. EMV cards add another layer of security against fraud for in-person sales. Embedded cards are the new standard for fraud protection and most credit card processors can provide EMV-compatible terminals.