How Does Credit Card Processing Work?

Credit card processing enables businesses to accept electronic payments, a fundamental component of modern commerce. This system ensures funds move securely and efficiently from a customer’s account to a business’s account. Understanding these mechanics offers clarity for both businesses and consumers navigating digital transactions.

Key Participants in Credit Card Transactions

The cardholder is the individual who uses a credit card for payment. The merchant is the business that accepts these payments.

A payment processor acts as an intermediary, handling transaction details. This entity communicates between card networks and financial institutions to authorize and settle payments on the merchant’s behalf.

The acquiring bank, also known as the merchant’s bank, holds the merchant’s funds and accepts money from sales. It provides infrastructure, such as payment terminals or online gateways, for card payment acceptance.

Card networks, such as Visa, Mastercard, American Express, and Discover, establish transaction rules and standards. They facilitate communication and fund transfers between the merchant’s bank and the cardholder’s bank. These networks form the foundational infrastructure for card payments, ensuring secure and efficient operations.

The issuing bank, or the cardholder’s bank, issues the credit card to the cardholder. This bank authorizes and approves transactions, ultimately providing the funds for the purchase.

The Transaction Flow: From Authorization to Settlement

A credit card transaction begins when a customer initiates payment. This can occur by swiping, inserting a chip card, tapping a contactless card at a terminal, or entering card details online.

The payment gateway securely transmits this information to the payment processor. The processor forwards an authorization request to the acquiring bank, which routes it through the appropriate card network. The card network directs the request to the issuing bank.

Within a few seconds, the issuing bank evaluates the request. It checks for sufficient funds or available credit, verifies the card’s validity, and confirms that the cardholder’s identity details match the information on file. The issuing bank then sends an authorization response, either an approval or a decline, back through the card network to the acquiring bank and ultimately to the merchant’s system. An approval signifies that the transaction can proceed, placing a hold on the customer’s funds.

After the transaction is approved, the merchant gathers all approved transactions into a batch. This batch is submitted to the payment processor, usually at the end of the business day. This process, known as batching, bundles the day’s transactions for clearing and settlement.

Upon receiving the batch, the payment processor forwards transaction details to the card networks for clearing. The card networks communicate with issuing banks, which convert temporary holds on cardholder accounts into permanent charges. This stage involves the actual movement of funds. The issuing bank transfers funds to the acquiring bank, which deposits the net amount, minus applicable fees, into the merchant’s bank account. This final transfer of funds to the merchant typically occurs within one to three business days.

Understanding Processing Fees

Credit card processing involves various fees set by card networks, banks, and payment processors. These costs typically range between 1.29% and 3.45% per transaction, depending on factors such as the card network, card type, and business industry. Card-present transactions generally range from 1.70% to 2.05%, while card-not-present transactions, such as online purchases, often incur higher fees, ranging from 2.25% to 2.50%.

Interchange fees constitute the largest portion of these costs, often representing 70% to 90% of total processing fees. These are fees that merchants pay to the issuing banks. Interchange fees compensate issuing banks for costs associated with issuing cards, processing transactions, managing risk, preventing fraud, and funding customer rewards programs.

Card networks establish these fees, which are typically a percentage of the transaction amount plus a fixed fee. These rates are not static and are subject to adjustments, often twice a year, by major card networks like Visa and Mastercard. For example, the average credit card interchange fee in the U.S. is approximately 2% of the transaction value, while debit card interchange fees in the U.S. are capped at $0.21 plus 0.05% of the transaction value due to the Durbin Amendment.

Assessment fees are another component, imposed directly by the card networks, such as Visa, Mastercard, Discover, and American Express. These fees cover the operational costs of the card networks and help fund the underlying payment infrastructure. Unlike interchange fees, assessment fees are non-negotiable and are passed to merchants by their payment processors. They are typically a small, flat-rate percentage of the monthly transaction volume for each card brand and can also be adjusted by the networks periodically.

Payment processor markups, or processor fees, are charged by the payment processing company for their services. These markups cover the processor’s operating costs and profit. Processor markups can be structured as a flat fee per transaction or a percentage of the total amount. They typically represent 20% to 25% of the total transaction cost and are generally negotiable, varying significantly between different providers and based on the business’s transaction volume and chosen pricing model. Common pricing models include interchange plus, tiered, and flat rate.

Security and Fraud Prevention in Processing

Security measures are integrated throughout credit card processing to protect sensitive data and prevent fraud. The Payment Card Industry Data Security Standard (PCI DSS) is a global set of requirements ensuring all entities processing, storing, or transmitting cardholder data maintain a secure environment. Compliance with PCI DSS is mandatory for businesses handling credit card information, aiming to reduce payment card fraud and data breaches. Non-compliance can result in significant penalties, fines, or inability to process transactions.

Encryption is a security technology that transforms sensitive credit card information into an unreadable, coded format during a transaction. This scrambled data can only be deciphered by a unique decryption key, preventing unauthorized access. Encryption is primarily utilized for card-present transactions, safeguarding information from the point of purchase until it reaches its destination.

Tokenization enhances security by replacing sensitive card data with non-sensitive, unique identifiers known as tokens. These tokens are random strings of numbers that hold no inherent value if intercepted, making them useless to attackers. This process helps reduce the risk of data breaches as actual card data is not stored on merchant servers, simplifying PCI DSS compliance. Tokenization complements encryption, providing an additional layer of data protection.

EMV chip technology, a global standard for credit and debit card transactions, uses embedded microprocessor chips to authenticate payments. For each transaction, EMV chips generate a unique cryptogram, making it difficult to clone cards and significantly reducing card-present fraud. This technology has seen widespread adoption, with over 95% of card-present transactions globally utilizing EMV cards.

Fraud detection tools are employed to identify and prevent suspicious transactions. The Address Verification Service (AVS) compares the billing address provided by the customer with the address on file with the card-issuing bank. Primarily used for card-not-present transactions, AVS helps confirm cardholder identity. The Card Verification Value (CVV/CVC) is a three or four-digit security code printed on the card itself, not stored on the magnetic strip. This code is requested for card-not-present transactions to ensure the physical card is in the cardholder’s possession, reducing the risk of fraud from stolen card numbers.