How Credit Card Processing Works

Credit card processing is a crucial part of any business that accepts credit card payments, whether you run a small retail shop or a large e-commerce platform. Understanding how credit card processing works can help you make informed decisions about which payment processor to choose for your business. In this blog, we will break down the process step by step and explain the key components involved in credit card transactions.

1. The Cardholder Initiates the Payment

The credit card processing journey starts when a customer makes a purchase using their credit card. This could be done in-person, through a point-of-sale (POS) terminal, or online through an e-commerce site. When a customer uses their card, the payment process kicks off, and the information needed to authorize the transaction is sent to the payment gateway.

2. Payment Gateway Handles the Transaction Request

A payment gateway is a secure software or service that facilitates communication between the business and the financial institutions involved in the transaction. It collects the cardholder's information, including the credit card number, expiration date, and CVV (Card Verification Value), and sends it to the payment processor for verification.

The gateway encrypts the transaction details, ensuring that sensitive card information is protected during the process. This encryption helps to maintain the privacy and security of both the business and the customer.

3. The Payment Processor Verifies the Payment

Once the payment gateway sends the payment request to the processor, the processor's role is to ensure that the transaction is legitimate and that funds are available in the customer’s account. The processor communicates with the customer’s bank (the issuing bank) to verify the card details and check for sufficient funds.

The processor performs a series of checks, including verifying the card's validity, ensuring that the transaction doesn’t appear fraudulent, and making sure that the customer has enough available credit to complete the purchase.

4. Authorization from the Issuing Bank

Once the payment processor checks the cardholder’s information, it sends the transaction details to the issuing bank for authorization. The issuing bank is the bank that provided the credit card to the cardholder.

The issuing bank evaluates the payment request by checking various factors such as account balance, available credit, and fraud detection algorithms. If everything checks out, the bank will authorize the payment and send an approval message back to the payment processor.

At this stage, the bank will place a temporary hold on the funds to reserve them for the transaction. If the transaction is approved, the authorization code is sent back to the payment processor.

5. The Merchant's Bank Receives the Authorization

Once the payment processor receives authorization from the issuing bank, the processor forwards the approval to the merchant’s bank, known as the acquiring bank. The acquiring bank receives the authorization code and informs the merchant that the payment has been approved.

The merchant can now proceed with processing the sale and completing the transaction. At this point, the payment is not yet fully transferred to the merchant; it is simply authorized.

6. The Merchant Completes the Sale

After receiving the approval, the merchant completes the sale, and the customer receives their product or service. The transaction is recorded in both the merchant’s system and the payment processor’s system, confirming the purchase.

This is the point at which the funds are considered "pending," as the merchant has received approval to proceed but still needs to finalize the transfer of funds.

7. Settlement and Fund Transfer

The final step in the credit card processing cycle is the settlement. After the transaction is authorized and the sale is completed, the merchant submits a batch of authorized transactions to the acquiring bank for settlement.

The acquiring bank then sends the transaction details to the credit card networks (Visa, MasterCard, etc.) for final processing. The networks route the transaction to the issuing bank for the actual transfer of funds.

Once the payment is approved by the issuing bank, the funds are transferred to the merchant’s account, minus any fees charged by the processor and acquiring bank. This usually takes a few business days, depending on the bank and the processor.

8. Fees Involved in Credit Card Processing

Credit card processors charge fees for their services, which vary depending on the provider and the type of payment processing solution you choose. Common fees include transaction fees, monthly fees, chargeback fees, and setup fees. These fees can differ based on factors such as transaction volume and the risk level associated with your business.

It’s important to review and understand the fee structure before selecting a payment processor to ensure that it fits within your business’s budget.

Conclusion

Credit card processing is a multi-step process that involves several parties working together to ensure that payments are securely and accurately processed. From the cardholder’s initial payment to the transfer of funds to the merchant’s account, each step is essential for completing a successful transaction. Understanding how this process works is crucial for businesses to ensure smooth transactions and avoid common pitfalls.