If you’re running a business, you could be leaving a lot of money on the table by not accepting credit card payments. According to Intuit, not accepting credit cards can cost the typical business $7,000 in annual sales. At the same time, it’s easy to understand how the various fees and requirements of accepting credit card payments can make the prospect seem daunting and complex – and most of all, potentially costly.
A lot goes into setting your business up for credit card payment processing. Between numerous middlemen and different rate plans, there’s a lot to consider. Even with the apparent upside of being able to offer customers more payment options, it’s not hard to understand why some businesses drag their feet about enabling credit card payments.
The resistance may be unfounded. Though credit card payments are indeed a bit more complicated than cash, with lots of variability in vendors and pricing models, taking some time to understand how these payments work as well as the various processing fees involved in accepting credit card payments can help you to find a solution that will best meet your – and your customers’ – needs.
To start, let's discuss what exactly occurs when you accept a credit card payment from a customer.
Payment Processing Ins and Outs
Let’s start off with a scenario that we’re all familiar with. A customer visits a business to make a purchase. When rung up, she opts to pay with her credit card. Four parties are initially involved with the transaction:
- The customer
- The business
- The issuing bank (the bank that issued the credit card)
- The acquiring bank (the Merchant Account Provider’s bank)
We expound on this further in this article, but there are many behind-the-scenes players powering payment processing. In brief, they include:
- Card Associations: They set the rules and manage Interchange for the credit card brands (Visa, MasterCard, Discover and Amex)
- Payment Processors: They maintain the computer network that supports communication between the Merchant Account Provider and banks
- Payment Gateways: They facilitate the transfer of information between the credit card terminal and Payment Processor.
- If your credit card terminal is managed by a different company, that is an additional entity you will have to deal with.
Some of this complexity can be bypassed by working with a Payment Facilitator like Square or PayPal. These companies are ideal for small-scale businesses due to their quick setup. That said, they can also hold funds from your bank account since they don’t underwrite their customers. The funds are held in the event of a chargeback.
We know, there are many parties involved. That’s what we meant when we said credit card payment processing is more complicated than depositing cash in your bank account. Unfortunately, not accepting credit cards can be dire for a business — especially since credit cards are the preferred payment method for larger purchases, according to CreditCards.com.
Most businesses turn to a Merchant Service Provider or bank with a merchant services division for their payment processing needs. The issuing bank charges the Merchant Service Provider an Interchange fee for the transaction. The issuing bank charges the Merchant Service Provider an Interchange fee for the transaction. This fee varies greatly due to factors like credit card type and risk. This Interchange fee is passed onto the business while the Merchant Service Provider simultaneously charges the business a markup to process the transaction.
You can also choose to work with a Merchant Service Provider that provides all the services related to processing credit card payments in one. This will reduce the number of middlemen you have to deal with and can improve the clarity and transparency of your billings. The more streamlined your services, the easier it is to focus on other important aspects of your business.
Credit Card Transaction Processing: Here’s What Happens, Step By Step
How do all of these various parties interact to get you paid? Here’s a simplified version of what happens when a customer pays by credit card:
- The customer presents their credit card to the merchant at the point of sale.
- The customer authorizes the transaction amount by keying in their PIN number, signing a receipt or using a mobile payment device.
- The transaction details and customer’s credit card details are sent electronically to the acquiring bank.
- The acquiring bank passes the transaction details onto the credit card association.
- The credit card association requests payment authorization from the issuing bank.
- The issuing bank validates the validity of the customer’s credit card, determines whether the cardholder has sufficient credit available to cover the transaction and approves or declines the transaction.
- The approval or rejection is sent back to the business via the same channels.
- After a transaction is authorized, the issuing bank places a hold for the amount of the purchase on the customer’s account.
- The merchant’s payment terminal will collect all approved transactions in a batch, which is later sent to the credit card association for settlement.
- The issuing bank transfers funds back to the business’s merchant account.
- Your merchant account is debited the processing fees for the transactions. (Timing of the fee may vary depending on the provider.)
E-commerce credit card payments involve additional steps, as they require additional communication between your shopping cart software and Payment Gateway.
Payment Processing Fees Explained
How much money your business is left with after a transaction comes down to the processing fees involved. The acquiring and issuing banks are both taking a risk on the transaction. From the perspective of the issuing bank, the customer could fail to pay his credit card bill. From the perspective of the acquiring bank, the customer could file a chargeback if the product is deemed insufficient, doesn’t arrive or is the result of a stolen or fraudulent credit card.
While it is understandable that these services – and the resulting risks each party takes on – will all incur fees for businesses that wish to use them, the number of different types of fees as well as the variability between providers, can make understanding credit card payment processing fees a confusing prospect.
Payment processing fees by the various providers involved in credit card payments are typically levied on individual transactions and may be flat-rate or based upon a percentage of the transaction amount. And that’s usually not the only charge associated with credit card payment processing. You may also be charged monthly service fees as well as for any hardware or equipment required to process credit cards. Lastly, you can also be billed for chargebacks and other incidental occurrences.
But did you know that some of the fees associated with credit card processing are mandatory, consistent and non-negotiable while there is a tremendous amount of variability in other types of charges? Wholesale fees reflect the processing costs imposed by credit card issuing banks and credit card associations. These are non-negotiable and are the same regardless of which Merchant Account Provider you use. Markups, meanwhile, are the fees paid to your Merchant Account Provider and Payment Gateway Provider, and vary in many ways, including the rate and fee model. Small differences in how providers bill you can amount to a big difference in the total fees you end up paying.
Factors that Affect Transaction Fees
If this all isn’t complicated enough, even the wholesale rates that you pay to process individual transactions can vary. This is due to the variability of risk involved.
To better understand why this is, imagine that your business sells office supplies. Compare the following scenarios: in the first, a customer comes into your store and purchases about $20 worth of paper and pens. They pay by credit card, correctly entering their PIN directly into your credit card terminal to verify.
In the second scenario, a customer calls your business to place a large order of supplies, valued at $1,500, for delivery. Because they are remote, they read off their credit card number to you over the phone for processing.
As a lender, which of the above scenarios would strike you as being more at risk for fraud or non-payment? Credit card processing fees are often assessed with risk level in mind. Here are some variables that determine the risk level:
- Whether or not the credit card is present at the time of the transaction: transactions where the card can be physically verified via a chip reader or by swiping are considered to be less risky than card not present (CNP) transactions. CNP fraud represents the greatest proportion of payment card fraud due to the fact that it is difficult to verify remotely that a customer is not using a stolen credit card number or counterfeit card.
- Whether the transaction is swiped or keyed: EMV chips are considered to be the most secure method of transmitting credit card information. When a transaction is verified using the magnetic strip on a credit card, the same information is used on every transaction, allowing the data to be captured and duplicated. EMV chip cards generate unique, one-time codes for each and every transaction, reducing the risk of fraud.
- The type of business you run: in the U.S. all businesses are categorized using a four-digit Standard Industrial Classification Code and Merchant Category Code. These describe the types of goods and/or services you sell and provide creditors with a sense of the risk level of your typical transactions. Types of businesses with higher typical risk levels may face higher transaction fees.
In addition to the underlying wholesale rates, the markups charged by your provider will ultimately impact your total costs for processing credit cards.
Now that you have an understanding of why credit card processors charge the fees they do, and why variability exists, it’s important to understand the types of fees to which credit card processing is subject.
Transactional fees: Each credit card transaction you process incurs a cost to your business. This is typically taken off the top of the total transaction value and may be comprised of a percentage of the transaction value or a flat fee per transaction or both. These fees are actually several fees rolled into one, including:
- Interchange fees: These are set by the credit card association and paid to the issuing bank. True interchange fees vary depending on the risk factors described above, as well as other criteria. While Payment Facilitators try to simply this variable fee charge tiered Interchange fees, meaning business pay a set percentage based on three fairly broad risk categories, qualified, mid-qualified and non-qualified. The problem is this tiers are not regulated and it can be difficult to understand why a transaction is classified at a lower tier (resulting in a higher fee). If your business takes care to verify transactions using chip technology and running AVS verification, the fees you pay on each transaction may exceed their true risk level – meaning you are paying more than you should be. Interchange-plus plans pass along the true Interchange cost plus a flat markup.
- Assessments: These are fees charged by credit card associations for running premium branded cards.
- Markups: These are additional fees beyond the Interchange that are applied by acquiring banks and payment processors to every transaction.
Scheduled fees: These are ongoing monthly and/or annual fees covering the services provided by your payment processor(s) and any equipment you use. Each and every provider you sign on with directly who is involved in credit card processing, including your Merchant Account Provider and Payment Gateway Provider, may charge its own fees (with its own separate billing and contract). But while some providers might charge for things like monthly reports or printed statements, other providers do not charge anything beyond fees associated with individual transaction. You can reduce and streamline these ongoing charges by looking for a provider that doesn’t tack on an extra service fee as well as by selecting a single vendor who offers both Merchant Account Provider and Payment Gateway services under a single billing model.
Chargebacks: Chargebacks occur when a customer disputes a charge, resulting in the reversal of the fees you were paid. When a customer disputes a transaction, the billing is removed from their statement and charged back to your business. Though in some cases, a chargeback may be due to an erroneous fraud report by a cardholder that can be quickly cleared up and reversed, the liability rests on businesses in cases where fraud did occur after a chip card was processed incorrectly. Cardholders’ banks may also initiate chargebacks – even if a transaction is approved – if a chip card is swiped and not inserted.
Incidental charges: In addition to one-off fees such as chargebacks, your credit card processing provider may charge for things like terminating your agreement mid-contract. But even contract exit fees vary from provider to provider – and some may not charge penalties for leaving at all, allowing businesses to sign on on a month-to-month basis. This again underscores the importance of comparing all of your credit card processing options before signing on with a provider.
Does This Mean Credit Card Processing Fees are a Necessary Evil?
If businesses that don’t accept credit cards are poised to lose thousands of dollars annually, but processing fees are a minefield of markups is there any way to make processing card payments more manageable?
As we’ve already mentioned, your choice of payment processor can make a big difference on the ease and cost of accepting credit card payments. Here are some things you can do to reduce your costs:
- Compare the per-transaction costs and Interchange models of various vendors. Variability in both can result in major fees savings on each and every transaction. For example, while the difference between a 2.55% and 3.5% fee on a keyed credit card transaction might not sound huge, the incremental savings can add up to the tens of thousands – or more – over a year
- Look for a provider that doesn’t charge unnecessary ongoing fees and instead includes any software and equipment and things like statements within their transaction fees.
- If your business offers e-commerce sales, look for a Merchant Account Provider with a built-in Payment Gateway – and avoid those fees altogether.
- Opt for a payment with state-of-the-art verification capabilities and features such as remote signatures to improve your ability to fight chargebacks.
- Sign on with a provider that won’t lock you into a contract and impose steep penalties should you wish to change processors.
Does your business accept credit cards? What was most surprising to you when you set up your credit card payment processing? Let us know in the comments section below!
Editor's Note: This post was originally published in December 2016 and has been updated for comprehensiveness and accuracy.