How Credit Card Processing Works

Accepting credit card payments enables your business and you to get paid. Business owners are savvy consumers themselves because they evaluate numerous products and services required to keep their business running. Choosing the right credit card processor is a crucial business decision because it’s your partner whose services extend beyond the core service of processing credit card payments.

As a business owner, it is vital to understand how credit card payment processing works and your options when searching for processing providers.

Who are the Actors in a Credit Card Transaction?

Cardholder – The person who obtains a credit card from an issuing bank and uses it to pay for goods and services.

Issuing banks – Banks, credit unions, and other institutions that issue credit and debit cards to cardholders via the card associations.

Card associations – American Express, Discover, MasterCard, and Visa. Each of these card associations (credit card issuers) set qualification guidelines and interchange rates. They also act as arbiters between acquiring banks and issuing banks.

Merchant – Any type of business that accepts credit card payments in exchange for goods and services.

Payment processors – Companies that process credit card transactions and connect card networks, merchants, merchant banks, and others.

Credit Card Technology

To be able to process credit card payments, you’ll have to get the right technology.  The most basic piece of technology involved in card processing is the EMV Smart Terminal. Brick-and-mortar shops and restaurants often use them to process cards physically. The EMV Smart Terminal will either read the chip in the credit card or scan the cards’ magnetic strips to process the transaction. Since the encrypted chip is more secure, most credit cards today use that rather than the magnetic strip. Fraudsters have the ability to collect information from the magnetic stripe and steal money from credit card accounts. On the other hand, the information on the chip is encrypted, making it harder for them to access.

Brick-and-mortar stores also use POS systems to conduct their credit card transactions. They are basically a combination of a cash register and credit card processor that makes both credit card and cash payments a more painless process.

Ecommerce businesses utilize online shopping carts that plug into their card payment services provider to enable the online credit card processing feature. Brick-and-mortar shops that conduct a portion of the business online can also use them as a payment processor.

The Motion of Credit Card Processing

When it comes to credit card processing, it works in three distinct processes: authorization, settlement, and funding.


When the cardholder comes to the checkout, they present their credit or debit card to a merchant in exchange for goods or services. The payment request might originate from a POS system or credit card terminal in a brick-and-mortar shop, an eCommerce site gateway, through in-app or mobile payment acceptance.

The merchant then sends a request for card payment authorization to their payment processor. The payment processor reaches the issuing bank by submitting transactions to the appropriate card association. Authorization requests that are made to the issuing bank include parameters such as AVS validation, CVV, and expiration date.

The issuing bank either approves or declines the transaction – a transaction can be declined if there are insufficient available credit or funds, if payment is past due if their bank account has been closed, or other factors. The approval or denial status is then sent back along the line to the card association, merchant bank, and ultimately reaches the merchant.

Settlement and Funding

The merchant sends batches of authorized transactions to their credit card payment processor, who then passes the details of all transactions to the card associations. The associations communicate the appropriate debits in all issuing banks in their network.

The issuing bank charges the cardholder’s account for the specified amount and then transfers the funds to the merchant bank. The merchant bank then sends funds into the merchant’s account.

Difference between a Payment Processor and a Payment Gateway

The roles of payment gateways and payment processors differ, yet each is an essential component in the process of accepting credit card payments.

Payment gateway – software that encrypts and securely transmits the customer’s payment data to the payment processor. It enables the merchant to provide their customers with different payment options, such as bank transfers, credit and debit card payments, eWallets, and other payment methods.

Payment processor – Executes the transaction by transmitting encrypted payment data between the customer, the merchant, the issuing bank, and the acquiring bank. The payment processor often provides the equipment needed to accept credit card payments (e.g., POS terminal).

Payment Service Providers (PSPs) partner with acquiring banks and their credit card payment processors to offer merchants the capability of accepting card payments. They typically offer services in addition to processing transactions, and these services include PCI compliance, the ability to process different currencies, and fraud protection. The PSP sends the transaction information to a payment processor used by the merchant’s acquiring bank.

Credit Card Processing Interchange Fees Explained

Credit card transactions come with certain fees since several parties are involved in credit card processing (beyond the merchant and consumer). There are various fees charged at different steps to compensate for the payment processors and banks doing the work.

The first fee is the interchange fee between the issuing banks and the acquiring bank. The issuing bank deducts this fee before the acquiring banks receive payment for the products/services provided to pass along to the merchant.

Next, the payment processor or acquiring bank will also charge a small fee before depositing funds into the merchant’s account. In other words, if your business starts accepting credit card payments, it will receive slightly less than what the customer paid. These interchange fees are typically a combination of a percentage of the sale and a one-time transaction fee. The exact fee calculation depends on the card association (e.g., MasterCard, Visa, etc.).

Businesses that offer customers more reward opportunities, more cash back, or other perks usually have higher interchange fees, which amount to about 2% of the purchase price. Also, companies may have to pay recurring fees for services provided by payment processors or acquiring banks, which can include:

  • Monthly minimum fees
  • Statement fees
  • IRS report fees
  • Next-day funding fees
  • Other fees based on the services they are receiving

The Payment Processing Trends

In 2019, the Federal Reserve reported the cash wasn’t the most common payment method anymore, while credit and debit cards were becoming increasingly popular. Digital payment methods are also continually gaining momentum, which is partially driven by the influx of younger consumers. Businesses will surely benefit from introducing a variety of payment methods on their eCommerce sites or at the checkout counter. On the other hand, if your customers are already paying in cash, your business could benefit from introducing cash discount programs. These problems allow businesses to offer a variety of different payment methods but without charging large credit card processing fees.

In the future, more businesses will search for ways to simplify their payment stack. Businesses have about four acquiring banks and five gateway processors (on average). Perhaps their first gateway didn’t have a certain payment method they needed, so they added another gateway. Then, they added another because neither of the first two offered cross-border support. Eventually, in the name of improving their payment process, businesses end up with a multiplicity of payment solutions. But instead of improving it, they now struggle to manage accounts, payment data, integrations, and payouts.

Simplification is a rapidly-growing trend, and businesses are on the lookout for merchant processing companies that can provide all-in-one, reliable solutions. These solutions need to provide flexible and extensive coverage for almost anything a merchant wants to offer, but with fewer technology stack complications.

Advances in technology have made credit card processing a viable option for businesses of all sizes and across all industries (regardless of how complicated it may seem at first glance). Also, credit card transactions have become more efficient and safer and come with multiple levels of regulations. Bonita Payments can help you tailor the right POS system for your business. Our custom payment solution is guaranteed to help you increase profit wherever possible and keep both you and your customers happy for a long time to come. Contact us for more information about our services.

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