How Does a Merchant Account Work?

A merchant account is a specialized financial arrangement that allows businesses to accept electronic payments, such as credit and debit card transactions. It is fundamental for any business processing payments beyond cash or checks. This account acts as an intermediary holding place for funds before they are settled into a business’s regular operating bank account. Without a merchant account, businesses cannot accept card payments from customers.

What is a Merchant Account

A merchant account is a bank account designed for businesses to receive funds from credit and debit card sales. It functions as a temporary holding account for customer card transactions before transfer to the business’s primary bank account. This arrangement is established through an agreement between the business (merchant) and an acquiring bank. The merchant account is distinct from a standard business checking account, as it is solely for processing electronic payments. It represents the underlying infrastructure necessary for card transactions to be processed and settled.

Key Players in Payment Processing

Electronic payment processing involves several interconnected entities working to ensure transactions are completed securely and efficiently. At the center is the customer, who initiates a transaction using their credit or debit card. The merchant is the business selling goods or services that accepts these electronic payments. Payments are processed through a network involving financial institutions and technology providers.

The issuing bank provides the credit or debit card to the customer and manages their funds. The acquiring bank contracts with the merchant to process electronic transactions. This bank manages the merchant account and receives funds from the issuing bank on the merchant’s behalf.

A payment processor acts as an intermediary, facilitating the flow of transaction data between the merchant, card networks, and banks. They handle the technical aspects of processing payments, ensuring authorization and data transfer. Card networks, such as Visa, Mastercard, American Express, and Discover, provide the infrastructure for communication between issuing and acquiring banks. They set interchange rates and establish rules governing card transactions.

How Transactions Work

An electronic payment begins when a customer initiates a purchase (e.g., swiping, inserting a chip, tapping a device, or entering details online). Encrypted transaction data goes from the merchant’s point-of-sale (POS) system or payment gateway to the payment processor. The processor forwards this information to the acquiring bank, which routes the authorization request through the card network.

Upon receiving the authorization request, the card network transmits it to the customer’s issuing bank. The issuing bank assesses factors like card validity, available balance, and potential fraud indicators. The issuing bank sends an approval or decline response back through the card network to the acquiring bank, payment processor, and the merchant’s terminal. If approved, an authorization code is generated, placing a hold on the customer’s funds, though the money has not yet moved.

At regular intervals, the merchant performs a “batch settlement,” sending all authorized transactions to their acquiring bank. This signals the acquiring bank to begin the clearing process. The acquiring bank then forwards the batched transactions to the card networks for clearing.

During clearing, card networks sort and present transactions to the issuing banks. Each issuing bank debits the cardholder’s account and transfers funds, minus interchange fees, to the acquiring bank. In the settlement stage, the acquiring bank deposits the net funds (total transaction amount minus various fees) from the merchant account into the merchant’s primary business bank account. This process, from authorization to final settlement, typically takes one to three business days for funds to become accessible to the merchant.

Getting a Merchant Account

Obtaining a merchant account involves a structured process, beginning with compiling necessary business and financial information. Businesses need to provide:
Legal business name, address, and type of business.
Employer Identification Number (EIN) or Social Security Number (SSN) for sole proprietors.
Financial details such as recent bank statements and projected monthly processing volumes.
Information about business owners or principals, including personal identification.

After gathering this information, the process to secure an account begins. The first step is researching and selecting a merchant account provider that aligns with the business’s needs. After choosing a provider, the business submits a formal application with all required documentation. This initiates the underwriting process, where the provider assesses the business’s risk profile, credit history, and financial stability to determine eligibility and set terms.

Underwriting can take a few days to several weeks, depending on the business’s complexity and the provider’s procedures. During this period, the provider may request additional information. Upon approval, the merchant account is set up, including configuring any necessary payment processing equipment or software. The business can then begin accepting electronic payments, with funds routed through the newly established merchant account.

Merchant Account Fees

Businesses accepting electronic payments incur various merchant account fees.

Transaction Fees

Transaction fees are charged each time a customer’s card is processed. These include:
An interchange fee, paid to the customer’s issuing bank, representing the largest portion of the processing cost (e.g., 1.4% to 2.5% for credit cards, 0.5% for debit cards).
An assessment fee, charged by card networks (e.g., Visa, Mastercard) for using their network, usually a small percentage of the transaction.
A processor mark-up, the fee charged by the payment processor or acquiring bank for their services.

Monthly Fees

Beyond per-transaction costs, merchants encounter monthly fees. These can include a statement fee for account reporting, a gateway fee for online payment processing, and a monthly minimum fee, charged if total transaction fees do not meet a set threshold. Some providers may also charge a one-time setup fee.

Compliance and Other Fees

PCI compliance fees cover adherence to the Payment Card Industry Data Security Standard (PCI DSS), which is mandatory for all businesses handling card data. These fees typically range from $5 to $10 monthly or $100 annually, with additional non-compliance fees if standards are not met. Chargeback fees are incurred when a customer disputes a transaction and requests a refund through their issuing bank. These fees typically range from $10 to $50 per incident, though they can be higher for businesses deemed high-risk.