How Chip and Signature Transactions Work in Credit Card Payments

Credit card security has evolved, with chip technology replacing magnetic stripes to reduce fraud. One verification method, chip-and-signature, requires customers to sign for purchases instead of entering a PIN. While more secure than older methods, it has limitations in preventing unauthorized use.

Transaction Steps in Chip-and-Signature

A chip-and-signature transaction involves multiple steps between the cardholder, payment terminal, and card issuer. Unlike chip-and-PIN, which requires a numeric code, this method relies on a signature for authentication.

Chip Interaction

When a customer inserts their card into a chip-enabled point-of-sale (POS) terminal, the embedded microchip communicates with the device to initiate the transaction. Unlike magnetic stripe cards, which store static data, the chip generates a unique, encrypted code for each purchase, preventing counterfeit fraud.

The terminal reads the chip’s information, including the card number, expiration date, and security protocols, verifying whether the card is active and not flagged for fraud. If the initial read fails, the system may prompt reinsertion. Once the encrypted data is processed, the transaction moves to identity verification.

Signature Capture

After retrieving the card’s details, the customer signs electronically on the payment terminal or a printed receipt. The signature is meant to match the one on the back of the card, though enforcement varies. Some businesses request identification, but this is not universally required.

For small transactions, signature collection may be bypassed if the purchase falls below a threshold set by the card network. Once captured, the transaction data is sent to the card issuer for approval.

Authorization Confirmation

The payment terminal transmits transaction details to the cardholder’s bank for authorization. The issuer evaluates available credit, fraud risk, and spending patterns before approving or declining the purchase, typically within seconds.

If approved, the terminal displays a confirmation message, and the customer receives a receipt. If declined, the merchant may request another payment method. In some cases, the issuer may require additional verification. Once approved, the funds are earmarked for settlement.

Merchant Reconciliation Approach

Businesses must ensure transaction records align with payments received from card networks and banks. This reconciliation process verifies that all sales, refunds, and adjustments are accurately recorded.

Merchants compare transaction reports from their POS system with settlement statements from their payment processor, detailing approved transactions, processing fees, and deductions like chargebacks or refunds. If discrepancies arise, they are investigated for possible processing errors, bank delays, or unauthorized activity.

Processing costs vary based on interchange fees, assessment charges, and acquiring bank rates. Visa and Mastercard set interchange fees that fluctuate depending on transaction type, card category, and merchant industry. Understanding these costs helps businesses optimize pricing strategies. Some use automated reconciliation tools integrated with accounting software to reduce manual errors.

Chargeback and Liability Factors

Disputes over credit card transactions can lead to chargebacks, where the transaction amount is reversed and deducted from the merchant’s account. Card networks like Visa and Mastercard set rules for chargebacks, outlining when they are valid and how merchants can contest them.

With chip-and-signature payments, merchants bear more risk than with chip-and-PIN because signatures are easier to dispute. If a cardholder claims they did not authorize a purchase, the merchant must provide transaction records, signed receipts, or other documentation. Since many businesses do not rigorously verify signatures, fraudsters can exploit this weakness.

Chargebacks also result from processing errors or customer dissatisfaction. Duplicate charges, incorrect transaction amounts, or failure to deliver goods can prompt a reversal if not resolved. Under the Fair Credit Billing Act (FCBA), consumers can dispute charges if they believe they were billed incorrectly or did not receive the promised goods or services.

Excessive chargebacks can lead to financial penalties. Card networks monitor chargeback ratios—the percentage of disputed transactions relative to total sales—and impose fees or account restrictions on merchants who exceed acceptable thresholds. Visa’s chargeback monitoring programs can result in higher processing fees or account termination. Merchants with high dispute rates may be required to implement fraud prevention measures such as address verification services (AVS) or 3D Secure authentication.

International Use in Card Transactions

Using a chip-and-signature card abroad can be challenging, particularly in regions where chip-and-PIN authentication is the standard. Many European, Asian, and Latin American payment terminals prioritize PIN entry, meaning transactions may be declined if a signature-based card is used at an unattended kiosk, such as train stations or parking meters. While staffed locations can process these cards manually, self-service machines may not accept them.

Foreign transaction fees are another factor. Most U.S.-issued credit cards impose a surcharge—typically around 3%—on purchases made in a different currency. Some premium travel cards waive these fees, but for those that do not, frequent international transactions can become costly. Exchange rates also vary, as banks and payment networks use daily rates that may differ from those offered by currency exchange counters. Understanding these costs helps cardholders make informed decisions when using their cards abroad.