How Does Payment Processing Work? Stages & Fees Explained
The simple task of receiving payment for goods and services involves intricate processes of authorization and approval.
Understanding payment processing structures and uncovering the fees and steps involved in credit card transactions can give businesses a clear picture of the complete purchasing process.
Using this information, businesses can make educated decisions on which systems to implement and identify which payment structure can help protect their bottom line.
The 3 Key Stages to Credit Card Processing
While credit card transactions seem straightforward on the surface, a number of strict procedures jump into action the second a customer enters in their payment information. No matter the platform, whether the transaction occurs in-store, online, or even via wireless terminals, there are 3 key stages necessary for credit card processing.
Stage 1 - Authorization of the Credit Card
In this initial stage, the seller is required to gain approval for the purchase from the client's bank of issue. The authorization process begins with the cardholder either handing over their physical card or entering the digits online. The client's credit card details are then sent wirelessly to the issuer, who then forwards them onto a credit card network.
Once the network has verified this payment, the authorization is sent to the customer's bank. This request includes the card expiration date, the card number, the card security code (such as the CVV or CVC), the billing address, and the amount of the transaction.
Stage 2 - Authentication
Once the request is in the hands of the bank, stage 2 of the processing system takes over. From here, the bank will validate the card number, ensure sufficient funds are available, and confirm that the card's billing address matches the number, before checking the CVV code. From this thorough check, the bank will then either decline or approve the payment and alert the aforementioned channels.
If the transaction is approved, the bank will put a hold on the precise transaction amount, allowing the seller's POS terminal to essentially collect the authorized amount - a task that is generally done in bulk at the end of the day. Finally, the client should be given a receipt as proof of the transaction.
Stage 3 - Settlement and Clearing
The moment the purchase is settled it will be displayed on the client's monthly card statement, alongside that of the seller's. At the end of the business day, the seller will then send all approved authorizations to the corresponding bank or processor, who will forward the information from the transactions to the credit card network to complete the settlement process.
From there, the network will send over the transactions to each issuing bank and the bank will transfer the funds (while also charging an interchange fee) typically within 24 to 48 hours of the transaction. The bank forwards this back to the credit card network that will then pay the receiving bank or processor the amount, minus the fees. Finally, the receiving bank deposits the money into the seller's account and the client will also receive a bank statement.
How Credit Card Processing Fees Work
Credit card processing fees can be more convoluted than what meets the eye. Bearing this in mind, it's crucial to understand the ins and outs of these additional payments to grasp the various pricing structures available to businesses.
Explore the key points below on how credit card processing fees work.
- Flat Rate - Just as it sounds, the flat-rate structure sees that merchants are charged either a set dollar figure or percentage. This price will not fluctuate depending on the size of the transaction. It's commonplace for card processors to ask for an additional percentage of the purchase amount - for example, $0.40 + 2% of the transaction.
- Tiered - Here, fees are charged on a tiered pricing structure, which includes qualified, mid-qualified, and non-qualified transactions. It may sound straightforward but this method can contain pitfalls for unwary businesses as processors will oftentimes purposely highlight or advertise the best rate to lure in customers without stipulating the expensive fees.
- Interchange Plus - With this pricing structure, a vendor will be asked to pay a specific amount for every transaction, as well as a percentage of that purchase (usually less than the flat rate option). Additionally, the merchant will also need to pay the interchange rate to the payment processor. These fees can fluctuate which means considerable research should be done before a business decides if the interchange plus model works for them.
- Membership - This structure requires users to pay a monthly subscription or membership, in addition to typically paying a small percentage per transaction. This structure can offer a great solution to companies battling consistently high credit card processing fees.
No matter which processing fee structure is selected, companies will be required to pay for the following standard expenses. These 4 factors will generally be accounted for in the chosen card processing fee model.
- Chargebacks - This sometimes-overlooked expense is on the rise. In fact, chargebacks against businesses are increasing by 20% each year. This occurs when a customer applies for a chargeback on their purchase; in which case, the customer's bank will then typically charge a fee to the business.
- Assessments - This fee will be paid to the credit card association and while the expense will vary (depending on the card a company uses and their pricing structure), it is usually a percentage amount.
- Interchange Fee - Nearly every credit card company issues out this fee, with the exception of American Express. This is the fee the payment processor and merchant bank pay to the issuing bank.
- Markups - This is the term given to what is fundamentally a revenue driver for merchant banks and payment processors. This fee is also charged to offset the costs of transmitting information and money.
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