What Is Credit Card Processing & How Does It Work?

Many businesses use a traditional full-service merchant account as their payment processor. A merchant account comes with a unique identification number that identifies the business to all parties involved in processing a transaction.

Merchant accounts are very stable but can be quite expensive for a small business. In addition to paying processing rates for each transaction, maintaining a merchant account also usually requires the payment of a variety of merchant account fees. However, large, high-volume businesses may be able to negotiate lower credit card fees.

To process eCheck or ACH payments, you’ll need a merchant services provider. This function usually requires a separate service as part of your account, but processing costs are very low.

Examples include Dharma Merchant Services and Helcim.

Payment service providers offer aggregated accounts where every merchant using the service shares the same merchant account. You won’t have a unique merchant account ID number when using a payment service provider, so accounts aren’t as stable as a true merchant account. However, overall costs are significantly lower for a small or newly established business.

Examples include Square, PayPal, and Stripe Payments.

While banks issue most credit cards, they’re also sponsored by a small number of credit card associations, such as Visa, Mastercard, Discover, and American Express. These entities charge a variety of fees whenever a purchase is made with one of their cards. These credit card processing fees are collectively known as interchange.

When a transaction is processed, the processor will charge you both interchange and markup in exchange for its processing service. Unfortunately, interchange rates vary widely based on the type of card used and other factors. This has made it easier for processors to rake in higher profits by offering merchants “simplified” processing rate plans (such as flat-rate or tiered pricing).

For this reason, we recommend merchant accounts that offer interchange-plus pricing for most low-risk, established businesses. The interchange-plus pricing method adds a fixed markup to each sale, regardless of the transaction type.

For example: interchange + 0.30% + $0.15 per transaction. While the interchange fee will vary widely with each transaction, the markup that you pay to your processor will always be the same.

Debit card transactions are much easier to process, as the issuing bank doesn’t have to decide whether to issue a credit to the consumer to cover the cost of the purchase. As long as there are sufficient funds in the consumer’s bank account, the transaction will usually be approved.

Because there is no need to issue a credit, the overall risk associated with debit card use is significantly lower than it is with credit cards. For this reason, the interchange rates for debit card use are substantially lower as well.

One of the reasons we encourage you to avoid tiered credit card pricing plans is that many of the processors that offer these plans charge the same rates for debit card use as they do for credit cards. This practice can result in you paying significantly more for debit card processing than you should. This is also a shortcoming with flat-rate credit card processing pricing plans offered by providers such as Square. However, the lack of account fees usually associated with these types of processors often outweighs this consideration, especially for small or seasonal businesses.

If you plan to accept debit card transactions and want to ensure that you pay the lowest possible rates, it’s important that you add a PIN pad to your countertop terminal setup. PIN pads allow your customers to authenticate their debit cards using their Personal Identification Number (PIN). This method is much more secure than simply collecting a signature from a customer, and you’ll pay the lowest processing rates available.

Without a PIN pad, your debit card transactions will process as credit cards, and the much higher credit card processing rates will apply.

In the United States, ACH (Automated Clearing House) payments that generate an all-digital payment from the customer’s checking account are very popular, particularly in the eCommerce sector. eChecks are the digital counterparts to paper checks and are typically processed much more quickly than paper checks.

eCheck and ACH payments go through a separate processing method than credit/debit cards. While it’s possible to have an eCheck-only service without the need for a merchant account, this arrangement won’t be practical for most businesses.

Because not all merchants need them, most merchant service providers offer eCheck processing as an optional service and charge a monthly fee for it (usually $20-$30). You’ll also have to pay a small transaction fee for each processed check, but it’s much less than most credit or debit card transactions.

If your business has a lot of overseas customers, you might also need to include localized payment methods that are popular in places outside the US. For example, AliPay and UnionPay are popular payment methods in China. You’ll want to do your research very carefully to find a provider that can support these payment methods, as they often don’t advertise their availability prominently.

Although it’s becoming less common, some consumers still prefer to pay by check whenever possible. Merchants can accept paper checks without the need for an eCheck processing service, and you’ll receive 100% of the sale price. However, you’ll have to make a trip to the bank to cash the check, and it might be rejected due to insufficient funds. There’s also the possibility of losing a paper check.

If you want to accept paper checks, you’ll also need a check scanner, which scans an electronic copy of the check and submits it to the customer’s bank to confirm the availability of funds. As long as the check won’t bounce, the transaction is approved immediately. Because of the monthly fees associated with most eCheck processing services, we recommend them only to businesses that accept a high volume of paper checks from their customers.

We’re using the term “digital wallet” here to include payment methods that rely on near-field communication (NFC) technology. NFC-based payment methods utilize small, very short-range radios in both the consumer’s payment device (typically a smartphone or smartwatch) and the merchant’s credit card terminal.

Apple Pay and Google Pay are currently the most popular forms of NFC-based payments. US-based issuing banks are now also beginning to roll out credit cards with NFC chips embedded in them, allowing the customer to wave their card over the payment terminal without having to swipe or dip it. The use of this payment method is growing, however, and merchants should consider adding it to meet the increasing demand.

NFC payment methods are ultimately tied to the user’s credit or debit card, and these transactions are processed as regular card transactions without any additional fees or markup. Other forms of digital wallet payments, such as Walmart’s proprietary Walmart Pay, use the smartphone’s camera to accept QR code payments.

While the majority of small businesses do not accept Bitcoin or any other form of digital currency, you might want to consider adding this payment option at some point. Merchant services providers usually go through a third-party processor to offer Bitcoin processing.

While not a payment method per se, gift cards reward customer loyalty and encourage repeat purchases. Gift cards are quite popular with consumers, and almost all merchant service providers in the industry can set you up with a gift card program as part of your merchant account.

Many POS system providers also offer gift card acceptance for an added monthly fee, e.g., $25/month.