How Credit Card Processing Works: A Step-by-Step Explainer

Credit card processing enables electronic payments for most consumer transactions today. This intricate, multi-party system ensures transactions are verified and funds transferred swiftly, often within seconds. While seemingly instantaneous to the user, a complex series of communications and financial movements unfolds behind the scenes to complete each payment. It facilitates the smooth flow of goods and services, a foundational element of the economy.

Understanding the Key Entities

The credit card processing ecosystem involves several distinct parties, each playing a specific role in facilitating a transaction. At the heart of the system is the Cardholder, the individual consumer who possesses and uses the credit card for a purchase. Opposite the cardholder is the Merchant, the business selling goods or services that accepts credit card payments from customers.

Merchants use a Point-of-Sale (POS) System or Terminal (physical or online) to initiate transactions. This system captures and securely transmits card details. A Payment Processor or Gateway acts as an intermediary, channeling transaction data from the merchant to card networks and banks. They also handle fraud detection and compliance.

The Acquiring Bank, also known as the merchant’s bank, is the financial institution that processes credit card payments on behalf of the merchant. Merchants must establish a merchant account with an acquiring bank to accept credit and debit card transactions. Conversely, the Issuing Bank is the financial institution that has issued the credit card to the cardholder and manages their account.

Connecting these banks are the Card Networks, such as Visa, Mastercard, Discover, and American Express. These networks provide the infrastructure to route transaction data and facilitate communication between acquiring and issuing banks. Card networks also set the interchange rates, which are fees paid to issuing banks.

The Transaction Authorization Process

The authorization process begins when a customer presents their card. The merchant’s POS system or payment gateway captures transaction details (card number, expiration, purchase amount) and securely transmits them to the payment processor.

The payment processor forwards this authorization request to the appropriate card network, which routes it to the cardholder’s issuing bank. The issuing bank performs real-time checks: verifying card validity, confirming sufficient funds or credit, and assessing for fraud.

Within seconds, the issuing bank sends an approval or decline message back through the card network to the payment processor, which relays it to the merchant’s POS system. If approved, an authorization code is provided, and a temporary hold is placed on the cardholder’s funds. If declined, an error code indicates the reason. This real-time communication typically completes in less than 10 seconds.

The Transaction Settlement Process

Following authorization, the settlement process transfers funds from the cardholder to the merchant. This typically occurs in batches, often daily. The merchant submits approved transactions to their payment processor or acquiring bank for clearing.

The acquiring bank sends these batched transactions through the card networks. The networks coordinate with issuing banks to transfer funds. The issuing bank debits the cardholder’s account.

Funds are then transferred from the issuing bank, through the card network, to the acquiring bank, and deposited into the merchant’s business bank account. This transfer generally takes 1 to 3 business days. Fees are deducted at various stages, including interchange fees (to issuing bank), assessment fees (to card networks), and processor markup fees. These processing fees typically range from 1.5% to 4% of the transaction value, plus $0.10 to $0.30 per transaction.