What Is Merchant Payment Processing?

Merchant payment processing allows businesses to accept electronic payments, such as credit and debit card transactions. This system enables commerce beyond cash by securely moving funds from a customer’s financial institution to a merchant’s account. The process transforms a customer’s payment instruction into settled funds, often in seconds.

Key Participants and Technologies

The merchant payment processing ecosystem involves several distinct entities and technological components that collaborate to complete a transaction. Each plays a specific role in securely moving payment information and funds.

Merchant Account

A merchant account is a specialized business bank account where funds from electronic payment card transactions are temporarily held before transfer to the business’s primary bank account. Businesses require this account to accept credit cards or other electronic payment forms. It acts as an intermediary, facilitating the flow of money from the customer’s financial institution to the merchant.

Payment Gateway

A payment gateway serves as a secure bridge between a merchant’s website or point-of-sale (POS) system and the payment processor. It encrypts sensitive payment data for secure transmission over the internet. This technology is essential for online businesses, acting as the digital equivalent of a physical card terminal.

Payment Processor

A payment processor handles the exchange of transaction information between the merchant, the customer’s bank, and the merchant’s bank. This entity facilitates the authorization, settlement, and processing of electronic financial transactions. Payment processors provide the infrastructure and technology for businesses to accept various payment methods.

Card Networks

Card networks, such as Visa, Mastercard, Discover, and American Express, provide the technological infrastructure for credit and debit card payments. They act as the central communication system, facilitating the exchange of transaction data between issuing banks and acquiring banks. These networks also set transaction rules and standards, including interchange fees.

Issuing Bank

The issuing bank is the financial institution that provides credit and debit cards directly to consumers. This bank is responsible for approving or declining transactions based on factors like available funds or credit limits, and for managing the cardholder’s account.

Acquiring Bank

The acquiring bank, also known as the merchant acquirer, is a financial institution that processes credit and debit card transactions on behalf of the merchant. This bank receives transaction data from the payment processor, sends it to the card networks, and then receives funds from the issuing bank. The acquiring bank ultimately deposits the net amount into the merchant’s account.

The Payment Transaction Cycle

The journey of an electronic payment involves a precise sequence of steps, from initiation by the customer to the final transfer of funds to the merchant. This cycle typically includes authorization, capture, and settlement phases.

Initiation

When a customer initiates a payment, such as swiping a card or entering details online, the merchant’s point-of-sale system or payment gateway transmits the transaction data. This data includes card information and the purchase amount. The payment gateway encrypts this information before sending it to the payment processor.

Authorization

The payment processor forwards transaction details to the appropriate card network, which routes the authorization request to the customer’s issuing bank. The issuing bank verifies the cardholder’s account, checking for sufficient funds or credit and assessing for potential fraud. Based on this verification, the issuing bank approves or declines the transaction, sending this decision back through the card network to the payment processor. The processor relays the approval or decline message to the merchant’s system, allowing the sale to proceed or be halted. This process typically occurs within seconds.

Capture

Following authorization, the merchant captures the transaction, typically by submitting a batch of approved transactions to their payment processor at the end of a business day. This batching allows multiple transactions to be processed together. The processor then forwards these batched transactions to the card networks for clearing.

Clearing

Clearing involves the card networks coordinating with the issuing banks to prepare for the transfer of funds. During this stage, the card networks calculate and apply various fees, including interchange fees. The issuing bank then sends the funds, minus these fees, to the acquiring bank.

Settlement

Settlement occurs when the acquiring bank deposits the net funds into the merchant’s account. This typically completes within one to three business days after the transaction’s authorization, though some payment methods or configurations may offer faster settlement.

Common Processing Methods

Merchant payment processing adapts to various business environments, with distinct methods for different transaction types. These methods ensure secure and efficient payment acceptance whether a customer is in person, online, or using a mobile device.

In-person processing

In-person processing, often referred to as point-of-sale (POS) processing, involves transactions where the customer and their payment card are physically present. This method typically uses card terminals or mobile POS devices that read chip cards, swipe magnetic stripes, or accept contactless payments. Security features like EMV chip technology help protect against fraud by encrypting card data.

E-commerce processing

E-commerce processing handles payments for online stores where the card is not physically present. This method relies on payment gateways integrated with shopping cart platforms or hosted payment pages. Customers enter their card details directly into a secure online form, and the gateway encrypts and transmits this information for authorization. Advanced fraud detection tools are important for these card-not-present transactions.

Mobile processing

Mobile processing encompasses payments made via mobile applications or digital wallets, whether in-person or remotely. This can include tapping a smartphone at a contactless terminal using a mobile wallet like Apple Pay or Google Pay, or making purchases directly within a mobile app. Mobile processing leverages near-field communication (NFC) technology for in-person transactions and secure tokenization for app-based payments.

Understanding Processing Fees

Accepting electronic payments involves various fees that compensate the different parties involved in the transaction lifecycle. These fees are structured in several ways. Understanding these components is essential for businesses to manage their payment processing expenses.

Interchange fees

Interchange fees are a primary component of processing costs, paid by the merchant’s acquiring bank to the customer’s issuing bank for each transaction. These fees compensate the issuing bank for issuing cards, managing cardholder accounts, and assuming credit risk. Card networks set interchange fees, typically a percentage of the transaction amount plus a fixed fee, averaging close to 2% of the transaction value for credit cards in the U.S.

Assessment fees

Assessment fees are charged directly by card networks (e.g., Visa, Mastercard) to the acquiring bank and passed on to the merchant. These non-negotiable fees cover the card networks’ operational costs, infrastructure, and regulatory compliance. Assessment fees are often a small percentage of the total monthly sales volume, typically ranging from 0.12% to 0.15% for major networks.

Markup fees

Markup fees represent charges added by the payment processor or acquiring bank for their services. These fees cover the cost of maintaining the merchant account, providing payment processing technology, and customer support. The amount and structure of markup fees vary significantly among different processing providers, often including per-transaction fees, monthly service charges, or other administrative costs.

Different pricing models

Different pricing models consolidate these fees for merchants. Interchange-Plus pricing is transparent, separating the non-negotiable interchange and assessment fees from the processor’s fixed markup. For example, a merchant might pay interchange plus a set percentage and a per-transaction fee (e.g., 0.20% + $0.10).

Tiered pricing

Tiered pricing categorizes transactions into different rates: “qualified,” “mid-qualified,” and “non-qualified,” each with a bundled rate. Qualified transactions, often standard credit or debit card swipes, receive the lowest rate. Mid-qualified transactions may include rewards cards or keyed-in entries, incurring a higher rate. Non-qualified transactions, such as corporate or international cards, usually have the highest rates due to increased risk or processing complexity.

Flat-rate pricing

Flat-rate pricing simplifies costs by charging a single, fixed percentage plus a small per-transaction fee for all transactions, regardless of card type or transaction method. For instance, a common flat rate might be 2.9% + $0.30 per transaction. This model offers predictability and ease of understanding, particularly for businesses with lower processing volumes or a mix of transaction types.