How Do Credit Card Payments Work? Demystifying the Process

Overview of Card Processing

Understanding how credit card payments work is essential for any business looking to streamline their credit card processing and ensure seamless transactions. At its core, credit card processing involves a series of steps, starting from the moment a customer initiates a payment to the point where funds are transferred to the merchant's account. This intricate process allows businesses to accept credit card payments for goods or services, creating convenience for both the merchant and the customer.

For merchants, understanding each phase of the transaction process can help in identifying potential inefficiencies and improving the overall payment processing system. Additionally, awareness of credit card processing fees and their components, including interchange fees, assessment fees, and processor fees, can aid in selecting the cheapest way to take card payments that aligns with their business needs.

This article demystifies the credit card payment process by detailing the roles of key players, exploring the transaction lifecycle, and highlighting crucial aspects like processing fees, security, and common challenges. 

Key Players in Card Payments Acceptance

Understanding the key players involved in credit card payments is essential for any business professional seeking to streamline their credit card processing operations. Here are the primary entities that make credit card transactions possible:

Cardholder

The cardholder is the customer who initiates a transaction by presenting their payment card to purchase goods or services. Their role is straightforward: provide valid payment credentials, whether in person with a physical card or online through entered details. The transaction begins the moment the cardholder authorises payment.

Merchant

The merchant is the business that accepts the card payment in exchange for goods or services. Merchants rely on payment systems to capture the cardholder’s details securely and submit them into the wider processing network. Their role is to provide a reliable point of acceptance, whether that’s a point-of-sale terminal, an online checkout page, or a mobile device.

Acquirer

The acquirer, also called the acquiring bank, is the financial institution that works directly with the merchant to process card payments. The acquirer provides the merchant account and ensures transaction data is routed into the broader payment ecosystem. Once payments are approved, the acquirer deposits funds into the merchant’s account after deducting applicable processing costs. 

Issuer

The issuer is the financial institution that provides the payment card to the customer. When a transaction is initiated, the issuer verifies that the card is valid and that the cardholder has sufficient funds or credit available. The issuer is also responsible for ultimately releasing the funds that are transferred to the acquirer and, eventually, the merchant.

Card network

Card networks such as Visa, Mastercard, American Express, or Discover act as the central switchboard between acquirers and issuers. They set the rules for how payments are processed, facilitate the secure transfer of information, and establish the interchange fees that apply to transactions. Their role is to ensure interoperability so that a card issued anywhere can be accepted by merchants worldwide. For more details, visit our page on card payments.

Processor

The processor is the technology partner that manages the flow of transaction data between the merchant, the acquirer, the issuer, and the card network. Processors authorise transactions in real time, route data securely, and handle clearing and settlement on behalf of merchants. Their role is to keep payments moving quickly and reliably through the system. To explore more about payment processing, check out our article on payment processing.

By understanding the roles of these key players, you can better navigate the complexities of accepting card payments online and choose the right payment solutions for your business.

The Card Transaction Lifecycle

Understanding the lifecycle of a credit card transaction is crucial for merchants or business professionals aiming to streamline their credit card processing. Here’s a breakdown of each key stage.

Authorisation

The first step is the authorisation stage. During this stage, a request is sent to the issuer to verify the card details and ensure the card has sufficient available credit. A temporary hold is placed on the cardholder's available credit limit, but funds are not deducted immediately. This step ensures the card is active and has sufficient funds for the purchase, although it doesn't guarantee against potential fraud.

Authentication

The second step is authentication. This step is vital for ensuring the legitimacy of the transaction. Various tools are used to confirm the cardholder's identity, such as 3-D Secure, Address Verification Services (AVS), EMV chip technology, and near-field communication (NFC). Failure to authenticate a transaction can result in a decline.

Batching

Next comes batching. After a day’s worth of transactions, they are grouped into batches by the merchant’s payment processor. This step typically occurs at the end of the business day or within 24 hours. The grouped transactions are then sent to the acquirer for processing.

Clearing

Clearing is the stage where the acquirer submits the batched transactions to the respective card networks (like Visa or MasterCard). During the clearing process, the card networks communicate with the card issuers to confirm transaction details and calculate fees.

Settlement

The settlement stage follows clearing. In this stage, the card issuer transfers the approved transaction amount to the acquirer. The acquirer then deducts their processing fees before transferring the funds to the merchant's account. Settlement may take one to three business days.

Funding

Finally, the funding stage occurs. This is when the settled funds are actually deposited into the merchant’s bank account, making them available for withdrawal. This is the last step in the transaction lifecycle and completes the process.

For more insights on how the overall credit card payment system works, refer to our detailed guide on card payments. 

Processing Fees

Understanding credit card processing fees is crucial for managing your business's expenses efficiently. These fees can significantly impact your bottom line, so it's important to be aware of the different types and how they work.

Interchange Fees

Interchange fees are typically collected by banks that issue credit cards. These fees generally range from 1% to 3% of the transaction amount. 

Here is an example of what these fees could look like:

By closely monitoring and managing these fees, you can better handle your credit card processing expenses.

Scheme Fees

Scheme fees are small charges set by card networks like Visa and Mastercard for using their payment infrastructure. They’re applied as a small percentage of each transaction and are non-negotiable, meaning every business pays them regardless of which payment processor they use.

These fees may seem minor, but they contribute to the overall cost of accepting card payments, and being aware of them can help you manage your credit card processing fees.

Processor Fees

Payment processors charge various fees for their services, including batch processing, chargebacks, PCI compliance, equipment rental or purchase, keyed transactions, online transactions, cross-border transactions, and early contract termination. These fees can add up and it is essential to manage them effectively.

Understanding these fees and how they are applied can help you choose the credit card processing services that best suit your business needs.

For ways to optimise your payment processes and minimise costs, consider strategies such as negotiating rates with payment processors and increasing transaction volumes.

Security Within the Flow

One crucial aspect to understanding how credit card payments work is the security measures in place throughout the process. This section will delve into encryption and tokenisation, PCI DSS, and authentication protocols, all of which are vital for maintaining the security of card payments.

Encryption and Tokenisation

Encryption and tokenisation are pivotal in securing sensitive data during credit card processing. Encryption transforms sensitive card information into unreadable code using algorithms, ensuring it's secure during transit. Tokenisation, on the other hand, replaces sensitive card data with a unique token, which is meaningless if intercepted by unauthorized individuals. This dual-layer of protection minimizes the risk of data breaches and unauthorised access.

PCI DSS

The Payment Card Industry Data Security Standard (PCI DSS) is a set of security requirements designed to ensure that all businesses that accept, process, store, or transmit credit card information maintain a secure environment. Compliance with these standards is mandatory for all merchants to protect customer data. Non-compliance can result in substantial fines.

Authentication Protocols

Authentication protocols add an invaluable layer of security to the credit card payment process. Strong Customer Authentication (SCA) requires at least two of the following three elements: something the customer knows (e.g., password), something the customer has (e.g., phone), and something the customer is (e.g., fingerprint). This multi-factor authentication helps to ensure that the person initiating the transaction is the rightful cardholder.

To enhance your understanding of card security and the overall process, check out our articles on card payments, payment processing, and merchant credit card processing. Implement these protocols to effectively secure your transactions and protect your business and customers from potential fraud.

Understanding these elements of security within the flow of credit card payments is essential for any merchant or business professional aiming to streamline their credit card processing services.

Challenges with Transactions

Navigating the complexities of credit card transactions involves understanding various challenges that can disrupt the payment process. Two primary challenges are declines and chargebacks, each with its own set of implications for your business.

Declines

Transaction declines occur when a payment request is rejected, which can happen for various reasons. Declines can be frustrating for both you and your customers, so understanding why they happen is crucial.

Declines can impact your sales and customer satisfaction. Implementing robust card payment solutions and keeping your customers informed can help mitigate these issues. For example, clear communication about the decline reasons and suggesting alternative payment methods can enhance the customer experience.

Chargebacks

Chargebacks are one of the more serious challenges in credit card processing. A chargeback occurs when a cardholder disputes a transaction, leading to the reversal of the funds back to the cardholder. Banks can also initiate chargebacks without customer input in cases of merchant errors.

The chargeback process can be lengthy and involves several stages. Initially, the cardholder contests the transaction, leading the issuer to investigate. Funds related to the disputed transaction are usually held for several days or even weeks, and the bank may issue a provisional credit while reviewing the claim.

Chargebacks carry significant financial implications, including non-refundable fees that cover the acquirer's costs. As a merchant, you're often required to provide compelling evidence to challenge the claim, known as representment. The average representment win rate for merchants is about 32%, indicating the difficulty of successfully disputing chargebacks.

To reduce the risk of chargebacks, it's advisable to:

• Use advanced fraud detection tools.
• Implement strong authentication protocols.
• Maintain clear and accurate transaction records.

Exploring tips to accept payments securely can also help you mitigate these risks. For more information on securely accepting payments online, refer to our article on accepting payments online. Understanding these challenges comprehensively can contribute to more efficient payment processing and minimise disruptions to your business.