What Is a Merchant Account and How Does It Work?

A merchant account is a specialized business bank account that allows a business to accept and process electronic payments, such as credit and debit cards. It acts as a temporary holding place for funds from customer transactions before they are transferred to the business’s primary bank account. Its purpose is to enable businesses to participate in the electronic payment ecosystem, facilitating secure and seamless transactions.

How a Merchant Account Functions

An electronic payment transaction begins when a customer initiates a purchase using a credit or debit card. The merchant’s point-of-sale (POS) system or e-commerce platform sends the transaction data to a payment processor. This processor transmits the encrypted payment information to the acquiring bank, the financial institution that provides the merchant account.

The acquiring bank routes the transaction details through the card network, such as Visa or Mastercard, to the customer’s issuing bank. The issuing bank verifies the customer’s account, confirms sufficient funds or credit, and checks for fraud. Upon approval, an authorization code is sent back through the network, acquiring bank, and processor to the merchant.

After authorization, funds are temporarily held in the merchant account. The payment processor collects funds from the customer’s issuing bank and, after deducting applicable fees, deposits the remaining amount into the merchant’s regular business bank account. This settlement process occurs within 24 to 48 hours.

Types of Merchant Accounts

Businesses access merchant account services through various models. A “dedicated” or “traditional” merchant account involves a direct relationship between a business and an acquiring bank. These accounts suit businesses with higher transaction volumes or those seeking more control, often integrating with physical point-of-sale (POS) systems for in-person transactions.

“Aggregated” merchant accounts are offered by payment service providers like Square, PayPal, or Stripe. With this model, businesses process transactions under a single master merchant account held by the service provider. This setup simplifies the application process and is suitable for smaller businesses or those with lower transaction volumes.

Payment gateways facilitate the secure transmission of transaction data. While integrated with both dedicated and aggregated accounts, a payment gateway is not a merchant account itself. It serves as the interface that encrypts customer payment information and sends it to the payment processor, acting as the virtual equivalent of a physical card reader for online transactions.

Applying for a Merchant Account

Before initiating an application for a merchant account, a business needs to gather specific information and documentation. This includes general business details such as the legal name, address, and Employer Identification Number (EIN). Personal identification for business owners, like a Social Security Number (SSN) and a government-issued photo ID, is also commonly required.

Financial information is necessary, typically including projected monthly processing volume and average transaction size. Businesses may also need to provide bank account statements, business licenses, articles of incorporation, and potentially financial statements or a business plan. A voided check with the legal business name is often requested to link the merchant account to the primary business bank account.

Once all preparatory information is compiled, applying involves selecting a suitable provider and completing their application form. This submission often occurs through an online portal, though phone or in-person applications are sometimes available. After submission, the provider conducts an underwriting process, evaluating the business’s risk profile based on the provided documentation and industry.

Approval or denial follows this review. Upon approval, the merchant account is set up, which involves integrating the payment processing software with the business’s point-of-sale systems or e-commerce platforms.

Understanding Associated Costs

Merchant accounts involve various fees, which are typically structured under different pricing models. Interchange-plus pricing is often considered transparent, where the merchant pays the direct interchange fees and assessment fees, plus a small, fixed markup from the payment processor. Tiered pricing categorizes transactions into different tiers, each with a specific rate, which can sometimes lead to less predictable costs. Flat-rate pricing charges a fixed percentage and a fixed per-transaction fee, regardless of card type or transaction volume, offering simplicity.

Interchange fees are paid by the acquiring bank to the cardholder’s issuing bank and generally represent the largest portion of processing costs, typically ranging from 1% to 3% of the transaction amount. These fees vary based on factors like card type (credit vs. debit) and transaction method (card-present vs. card-not-present). Assessment fees are charged by card networks, such as Visa or Mastercard, for network operations and fraud prevention, usually a smaller percentage of the transaction.

Additional fees can include processing fees, which are the markup charged by the merchant service provider for facilitating the payment. Monthly fees or annual fees are common for account maintenance, while statement fees may be charged for receiving periodic transaction reports. PCI (Payment Card Industry) compliance fees cover costs associated with ensuring the business adheres to data security standards, often ranging from $10 to $100 annually, with non-compliance potentially incurring monthly penalties.

Gateway fees apply for the use of the payment gateway technology, particularly for online transactions. Chargeback fees are incurred when a customer disputes a transaction, covering the administrative costs of resolving the dispute. Other potential fees include setup fees, refund fees, and fees for specific situations like PIN debit transactions or address verification services.