Understanding Credit Card Processing
(The following information is available in the infoactive above, it is provided here for those individuals who wish to read through without the visuals)
As a merchant, you've probably wondered what happens from the time you accept your customer's credit card to the time you receive payment. There are in fact three main processes that ensure a successful sale.
The first process is called Authorization. During this process the credit card will be confirmed as valid, and whether it has sufficient credit to purchase goods or services. The next process is where the electronic payment transactions are managed so they can clear and be funded. This is also known as Settlement. The final stage of a successful credit card processing transaction is referred to as Funding. It is here that the Processor deposits money into your bank account to compensate you for the transactions processed.
Who are the Key Players?
When you process a credit card there are in fact more individuals involved than just you and the card holder. Five key players each play a role in the process, they include:
The Customer or Card Holder. While typically the individual who actually buys goods or services from a business. In this process, it can also refer to an individual authorized to use the card to make a purchase.
The Merchant. More generally known as a businessperson who buys and sells goods in order to earn profit. In this process, it is the legal entity authorized to accept the card for the goods sold or services rendered by the business.
The Processor is the merchant service provider that sends the details of the processing card transaction among the merchant, bank, and card issuers.
The Card Payment Brand refers to a consumer payment system with financial institution members who issue payment cards and sign the merchants to accept these cards. Some of the more common brands include Visa, Mastercard, and American Express.
The Card Issuer is the financial institution that issues payment cards and maintains contract with the cardholder for repayment.
Without authorization you won't be able to accept your customer's credit card for payment, and that could mean lost sales. You can obtain authorizations through a point–of–sale terminal, virtual terminal, smartphone swiper, e–commerce website, or over the phone. Authorization follows these steps. Generally, this entire process occurs within a matter of seconds.
- First depending on how you run the card, this information is transmitted to a Processor (for instance, in a card-present environment, you would manually swipe the card and enter the dollar amount, and then send this information to the Processor).
- Next the Processor forwards your request to the Card Payment Brand, such as Visa® or MasterCard®.
- From there, the Payment Brand sends your request to the Card Issuer (the bank that issued the card to the customer).
- The Issuer will then approve or decline the transaction, and sends this response back to the Card Payment Brand.
- Next the Card Payment Brand sends the response to the Processor.
- The Processor then forwards this response to you (either through your point-of-sale device, e-commerce website, over the phone, etc.), so you can complete the transaction.
- The card will then be approved, declined, or “referred” for the purchase.
- An approval means that the dollar amount you specified will be reserved from the cardholder's available credit limit for future settlement.
- A decline means that the customer's card cannot be used to complete the purchase.
As a merchant, the most important part of credit card processing is whether or not your customer is able to use his or her card.
If you receive a “decline” notification be aware that it may be for a number of reasons including if the cardholder has spent more than his or her credit limit` or if the credit card has been reported lost or stolen. You should also be know that it is not your responsibility to explain to the cardholder why his or her card was declined. In fact, the actual reason for the decline notification is not transmitted to you. If a customer requests more information about the denial, you should direct them to use the customer service contact information on the back of the credit card.
A referral is a request for additional information before an authorization can be issued, this request can be for information from either the merchant or the cardholder. An Issuer may send a referral response as a security measure.
If a referral is received, the Processor will contact the issuer directly and request authorization on your behalf. The issuer may request to speak with you or the cardholder over the phone to confirm the legitimacy of the transaction before the issuing the authorization.
A typical example of when this occurs is when the cardholder is trying to make a purchase in a foreign country, is using his or her card more than usual in a short period of time, or has reached the credit limit on the card.
Settlement is the the process of managing electronic payment transactions so they can clear and be funded. Depending on your business, your customer likely considers the sale complete once they have left your store, logged off your website, or hung up the phone. For you, however, the transaction is still in process, since it must now be settled. To make this happen, the approved card transaction must be presented to the Processor. The Processor then submits those approved transactions to the payment brands for clearing through interchange. You may hear these transactions referred to as 'deposit' transactions. Other costs to the acquirer include processing fees along with assessments and association fees. Processing fees are paid to the processor for running the transactions and settling funds. Assessments and association fees are paid to Visa®, MasterCard®, & Discover®
Interchange fees are fees that a merchant acquirer or merchant services provider pays to card-issuing banks.
The interchange category under which any single transaction falls will depend on various factors including:
The Processing Environment of the Business.
The location of card processing is just one of the factors in determining the fees applied against the transaction. Card Issuers consider purchases that occur in physical stores as less risky than those made online, over the phone, or even face-to-face in non-brick and mortar environments. As a result, cards processed face-to-face in retail locations typically have the lowest associated fees.
The Merchant's Card Acceptance Method.
The way card information is captured also plays a major role in the fees assessed to each transaction. Retail locations that physically swipe cards through their processing equipment are charged lower fees than those that type or "key in" the information.
Security Information Sent Along with the Transaction.
When the card information is collected, a merchant can collect additional data points to help decrease the risk associated with the transaction. Collecting items such as the cardholder’s address and/or zip code, also know as address verification or AVS, and sending this information with the transaction can help assure the card issuer that an authorized cardholder is using the card, rather than a third party for a fraudulent purchase. By reducing the risk of fraud, the merchant further reduces the fees charged on each transaction.
The Card Brand and Type Accepted.
As of October of 2012, more than 700 interchange rates existed among card brands and transaction types. Each card has its own associated rates, which vary based on the previously noted factors. The highest rates are often associated with Corporate and rewards cards, as the card issuers leverage the higher fees on these cards to finance the rewards and offers that the cardholders receive. The lowest rates are historically associated with debit cards; they were lowered even further following the Senate’s 2010 Durbin Amendment, which allowed the Federal Reserve to cap transactions fees for large institutions.
Examining how the Settlement process works:
- Typically your terminal or point of sale device automatically triggers, or "batches" a settlement, unless further steps are required - such as tip adjustment in a restaurant.
- The Processor then forwards your settlement request to the appropriate credit card payment brand for confirmation with the cardholder's issuing bank.
- The Payment brand receives the settlement request and does two things. First, issuing a credit to the Processor to reimburse you for the amount of the settled transaction. The issuer then pays the Processor for the transaction.
- After that the Payment brand issues a debit to the Card Issuer to charge for the settled transaction.
- The Issuer then posts the transaction to the customer or cardholder's account. At the end of the billing period, the issuer sends the cardholder his or her monthly statement.
- The cardholder receives his or her credit card statement and pays the bill to the card issuer.
The final part of the process is funding. It is at this time that the Processor deposits money into your bank account to compensate you for transactions processed. The funding process is really an extension of settlement, and sometimes the terms "settlement," "batching," and "funding" are used interchangeably regarding this process. Funding happens when the payment brands, such as Visa® or MasterCard®, reimburse the Processor for your customer transaction, allowing them to send these funds to you. Generally, merchants receive their funds within one to two business days. However it is important to note that funding does not occur on weekends or on certain holidays, particularly federal banking holidays.
We hope that this presentation provides a comprehensive look at the key players and processes required to accept a credit card at your business.If you would like to learn more about how this process works for your individual business or how Merchant Warehouse can leverage our knowledge and experience to save your business money, please contact us today at MerchantWarehouse.com.