How Credit Card Processing Works

How Credit Card Processing Works

For both consumers and businesses alike, credit card transactions are a daily occurrence. Fewer and fewer consumers are using cash to make purchases. In turn, businesses need to make sure they’re set up to accept credit card transactions in order to keep up.

Even most small businesses are finding that they need to offer customers the option to pay with a credit card. This makes it important for business owners and operators to understand how credit card processing works and exactly what happens when a customer uses a credit card to pay for their goods and services.

The Process

In real time, processing of a credit card payment happens quickly. However, there are a lot of parties involved and a lot of moving parts that make it possible. The first step is understanding the various parties that have to sign off on every credit card transaction:

  • The Cardholder – the customer who wants to purchase goods or services with their credit card. This person will apply for a credit card with a financial institution and be issued one accordingly.
  • The Merchant – the business selling goods and services. The business must reach an agreement with a financial institution before being able to accept credit card payments.
  • The Acquiring Bank – the banking institution that’s associated with the business selling their goods and services. They will deposit revenue from credit card sales into the account of the business and provide that business with the equipment necessary to conduct credit card sales.
  • The Issuing Bank – the banking institution that has issued the credit card being used to the customer. They will pay the cost of the goods and services purchased by the cardholder with the assumption the cardholder will pay them back.
  • The Card Association – the credit card company that’s overseeing the transaction, usually one of the four major associations: Visa, MasterCard, American Express, and Discover. These companies monitor the other parties involved in credit card transactions, create guidelines, and may intervene if there’s a dispute.
  • The Payment Processors – the third party often hired to handle credit card transactions on their behalf. They are usually independent sales organizations (ISO) or membership service providers (MSP) hired by the acquiring bank.

Every credit card transaction involves all of these parties, as well as three main steps: authorization, settlement, and funding. While they may seem a little complicated, authorization is typically done within a matter of seconds while settlement and funding are usually completed within 24 hours, if not sooner.

The authorization process begins when the consumer presents their credit card as a form of payment. When the credit card is swiped or scanned by the business, they are requesting payment authorization from the acquiring bank or the payment processor that’s acting on behalf of the bank.

The transaction is then submitted to the card association and ultimately the cardholder’s bank. Assuming the cardholder making the purchase is in good standing with their bank and card association, all parties will be notified that the transaction has been approved, allowing the merchant to accept the credit card as payment.

Once the credit card transaction has been authorized, the settlement and funding steps are next. The business will send a list of authorized credit card transactions to either their bank or payment processor. The payment processor sends these transactions to the card associations who then contact the issuing bank who charges the cardholder’s account.

The issuing bank can then send funds covering the cost of the goods and services to the acquiring bank minus the interchange fees that are being deducted. Finally, the acquiring bank deposits the funds from the transaction into the account of that business, giving them the money from the sale.

As credit card processing speeds up, the settlement and funding parts can sometimes happen overnight, enabling businesses to get their money from credit card sales in less than a day.

Credit Card Technology

There’s a fair amount of equipment and technology needed to process credit card payments. Naturally, that technology is evolving and improving to help expedite credit card payments while also making them more secure.

An EMV Smart Terminal is one of the most basic pieces of technology involved in credit card processing. They are often used by brick-and-mortar stores to physically process credit cards. These terminals will either scan the magnetic stripes on credit cards or read the chip in the card in order to process the transaction.

Most modern credit cards use the encrypted chip rather than the magnetic stripe because they are more secure. In the past, scammers had the ability to lift information from the magnetic stripe. However, credit cards that use chip technology have all of the information encrypted, making it more difficult for criminals to access.

Both restaurants and brick-and-mortar shops will also use Point of Sale solutions to conduct credit card transactions. These machines combine cash registers with a credit card processor so that cash and credit card payments can both be processed easily.

Online shopping carts plug in to your payment services provider to enable credit card processing. E-commerce businesses use them so they can accept credit card payments online. Traditional brick-and-mortar businesses can also use them as a payment processor in order to conduct business online.

How Credit Card Processing Fees Work

Fees go hand-in-hand with credit card transactions. With multiple parties beyond the consumer and merchant being involved in credit card processing, there are various fees charged at different steps in the process to compensate for the banks and payment processors doing the leg work on the transaction.

As mentioned, there is an interchange fee between the acquiring bank and the issuing bank. Before the acquiring bank receives payment for the goods and services provided to pass along to the merchant, the issuing bank deducts the interchange fee.

The acquiring bank or the payment processor will also take a small fee before depositing funds into the account of the merchant. This means a business that accepts credit card payments will receive slightly less for their goods and services than what the customer paid.

Interchange fees paid by merchants during credit card processing are usually a combination of a one-time transaction fee and a percentage of the sale. The exact calculations differ based on the card association, meaning the different credit card brands like Visa and MasterCard.

Companies that tend to offer customers more cash back, rewards opportunities, or other perks tend to have higher interchange fees. However, most of those will amount to approximately 2% of the purchase price.

Businesses may also be hit with recurring fees for services provided by acquiring banks or payment processors. These can include statement fees, monthly minimum fees, next-day funding fees, IRS report fees, and a multitude of others based on the services they are receiving.

Regulation of the Credit Card Processing Industry

Like any other industry, credit card processing requires regulation in order to ensure that all parties are operating in good faith. Fortunately, several overseers are in place to help regulate the credit card industry.

The Card Association Network is one of the main regulators. This organization is made up of the four major credit card companies: Visa, Discover, MasterCard, and American Express. Each of these companies is able to come up with their own interchange rates independent of the other companies.

The Card Association Network releases these interchange rates twice every year, once in April and once in October. This helps ensure that banking institutions and credit card processing companies know the rates to follow.

Another regulator is the Payment Card Industry Data Security Standard (PCI DSS). It was created by the four major credit card brands for the purpose of creating standards to be followed industry-wide and prevent instances of credit card fraud. All third-party payment processors that conduct business with the four major credit card companies must comply with the PCI DSS.

The federal government also plays a role in credit card regulation. Specifically, the Durbin Amendment, which was a late addition to the Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010, addresses the credit card industry. When enforced by the federal government, the Durbin Amendment requires the Federal Reserve to put limits on the fees that a business can be charged by credit card processors.


Credit card processing can seem complicated at first glance. There are a number of parties involved in the process, not to mention fees that need to be paid by merchants in order to accept credit card payments.

However, advances in technology have made it a viable option for businesses in all industries and all sizes. Credit card transactions have also become increasingly safe and efficient and come with several levels of regulation.

For most business owners, accepting credit card payments is a necessity. That means it is vital to understand as much as you can about credit card processing. This knowledge allows you to better weigh the options when you’re deciding between the potential vendors.

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