Credit card processing

A credit card is a payment instrument which is part of a complex payment system. They entitle cardholders to purchase goods and services using a line of credit granted by the card issuer to the user, from which the borrower can take away money and use it for payment to a merchant or as a cash advance. Credit cards are among the most widely used payment instruments around. One of the significant advantages of owning a credit card is the convenience of not having to carry cash around – however, while the credit card payments appear to simply “happen” with the swipe of a card and a few keystrokes, the process is in fact much more complicated. This is known as credit card processing.

The credit card processing is essentially a suite of steps which require near-instant coordination between multiple high-speed computer networks and involve several parties. Thus, in addition to the cardholder, who initiates the credit card transaction which needs to be processed, the credit card processing flow involves the card-issuing bank, the merchant (an individual or business accepting credit card payments for products or services sold to the cardholder) who owns a merchant account (a type of bank account that allows credit card payments acceptance for businesses), a transaction network and occasionally a third-party credit card processing company.

A credit card purchase can be made either in stores which have credit card processing terminals (point of sale transactions) or else over the internet – in this we talk about online credit card processing. Nowadays, given the high level of technological development, most of the credit card transactions carried out in stores are sent electronically to merchant processing banks for authorization, capture and deposit. The flow of data and money between the parties mentioned above is also referred to as interchange.

But how does the system actually functions? When a credit cardholder carries out a purchase, the card’s magnetic strip is read by a credit card terminal or reader, or else (in case of chip and PIN cards) the card’s chip is read by a reader or else by a specialized computer. In very rare cases, the credit card details are manually inputted into a terminal, a computer or website. This is known as manual credit card processing. The information is sent electronically by the merchant from the credit card payment processing terminal to the acquiring bank (the merchant’s bank, which will receive the money in exchange for the acquired product or service). The acquirer then contacts the card issuer to verify the credit card number, the transaction type and whether the cardholder has the necessary amount in his account. This phase is known as credit card processing authorization. Once the transaction has been authorized, an approval code will be issued which the merchant will store along with the transaction details.

Credit card processing

The next step in the credit card payment processing flow has to do with sending the batches of authorized transactions to the acquirer. Merchants usually submit on a daily basis, at the end of the business day. The acquirer then sends the batch transactions to the credit card processing company, which debits the issuers for payment and credits the acquirer. What basically happens is that the cardholder’s issuer bank pays the cost of the transaction to the acquirer. Once payment to the acquirer has been made, the acquirer pays the merchant and draws its own fee for processing the transactions.

When a credit card transaction takes place via the internet, the online credit card processing also takes place in two phases: authorization and settlement. During the authorization phase, the e-commerce merchant tries to determine whether a purchaser’s account is valid and can accept the transaction charge. An authorization request is sent by the merchant’s website to the payment processor, which in turn forwards the authorization request to the issuing bank. The authorization request demands that the following information be provided: the credit card number and expiration date, the billing address (used for AVS validation), the CVV number (if entered) and the amount of the order. The issuing bank proceeds to validate the card number and expiration, verifies the amount of the order against the available credit, approves the transaction if all details check out and reserves the amount of the order from the total of cardholder’s available credit. The settlement phase involves the actual processing of the sale and the transfer of funds from the cardholder’s issuing bank to the merchant’s bank.

In order to be able to accept credit card payments, a merchant must therefore open a merchant account. However, since in recent years banks have become less willing to provide small business credit card processing services, some merchants decide to sign up directly with a specialized credit card processor or else with an independent sales organization (also known as an ISO), which can provide assistance in obtaining both the equipment and training they need for credit card payments acceptance. Merchants prefer to establish credit card transaction functionalities as credit card transactions are regarded as a secure type of payment – or in any case, more secure than cash or check payments. Credit cards also allow cardholders to carry out a payment irrespective of whether they actually have the needed amount or else they must tap into their credit lines and contribute to boosting merchant profitability.

Credit card processing

However, merchants must also pay a number of fees for the benefit of being able to accept credit card payments. The discount rates charged by the credit card processors usually range between 1 and 3 percent of the value of a transaction, although they can be higher than 3 percent. Such fees will obviously impact (and usually drive up) a merchant’s total costs; the exact impact depends on a number of factors, such as size of each credit card transaction, the total volume of credit card transactions and the transaction types. However, most merchants will choose to pay the necessary credit card acceptance costs, as they are aware of how much this impacts a company’s profitability, particularly when it comes to accepting payments online. Usually, credit card processing fees are simply regarded as part of a company’s overall marketing expenses.