How Credit Card Processing Works: The Ultimate Credit Card Processing Guide for Retailers

Woman makes a purchase online and credit card processing starts

There are millions of credit card transactions every single day. And the few seconds that each of these takes is amazingly complicated. The fact that it happens as fast as it does (especially if you’re using a great retail POS system) is incredible. We’ll get more into this later in our look at how credit card processing works. First, let’s sum up the basic steps of the process. 

The 7 Steps of Credit Card Processing

  • The customer inserts, taps, or swipes the payment.
  • The merchant’s credit card machine sends a message to the credit card processing company or network. They are typically responsible for communicating with and connecting the other parties involved.
  • The credit card companies, or networks/associations, like VISA or MasterCard, receive the information to determine any fees the transaction might incur.
  • The processors also send the data to the issuing bank (the customer’s banking institution) to approve or deny the transaction.
  • The issuing bank sends an approved/declined response back through the processing company and to the terminal. The credit card associations tag the appropriate interchange fee to the transaction as well.
  • The money will be deposited in the acquiring bank (the merchant’s bank) between 24 and 72 hours after payments are batched.
  • Once deposited, the merchant bank deducts any applicable fees and distributes them to the proper receiving parties – issuing bank, credit card companies, and credit card processors.

Of course, there are many variables that can alter or interrupt this process, but this is generally how your run-of-the-mill transaction will work. At the most basic level, the process is meant to mitigate risk, assuring the safe transfer of funds for all parties involved. The merchant must be paid, the bank must be sure that the customer has a proper amount of funds, the customer must be confident that the amount deducted is accurate, and the money must be safely deposited in the correct accounts at the end of it all.

a graphic showing the steps of a credit card transaction

Why Should You Care About How Credit Card Processing Works?

It isn’t really necessary for most people to understand the intricacies of the process (though it’s fascinating to find out exactly how fantastically boring it is). But for any merchant, it’s absolutely vital to understand the basics: a proper awareness of the industry and your options can save you huge amounts of money, especially for businesses with a high volume of transactions. Plus, you need to be sure that your business can accept payments online and in-store.

So Who Is Everyone Involved in This Process Anyway?

The Credit Card Processor

Let’s start with the credit card processing companies. There are MANY of them, and you’ve probably only heard of one or two, if that. Retailers, however, usually have the freedom to choose any processor that they desire.

The processor is responsible for connecting each party involved. They send the initial data to the credit card company and the issuing bank and back. Equally important, they protect each party involved by ensuring that the transaction is following the Payment Card Industry Data Security Standards (often times simply referred to as PCI compliant). They charge a fee (either a percentage of a transaction or a flat rate) for these services. The rates vary depending on the processing company. Check out our blog on how PCI Compliance works for retailers.

It is also worth noting that some POS solutions also act as payment processors. In these cases, all fees – interchange, assessment, processor – are usually bundled into one rate. While straightforward and simple, it’s often times a higher rate than keeping your point of sale and credit card processing separate.

Credit Card Companies/Associations

The credit card companies or associations are the names that everyone recognizes – VISA, MasterCard, AmEx, etc. They don’t actually facilitate the transactions or provide any cash to settle funds. Rather, they are responsible, along with the banks, for determining the interchange fees for each transaction. These fees vary from business to business and transaction to transaction and cannot be negotiated with your processor. The associations set these fees based on hundreds of factors, most of which surround the determined risk of the transaction. The credit card companies also take care of marketing for the industry as a whole by encouraging customers to use cards instead of cash. And to simply spend more money. These fees typically account for anywhere between 70 and 90% of the total fees a merchant pays per transaction.

Issuing Bank

The issuing bank is simply who the customer chooses to bank with. The issuing banks are responsible for distributing the funds and assume the risk of fraudulent transactions. They also must give the final say on the release or acceptance of funds into an account. For their service, the issuing banks receive the majority of the interchange fees. 

Acquiring Bank

At the end of each business day, the merchant should batch all transactions made from the prior 24 hours (delayed batching will result in higher interchange rates). Within 24-72 hours of batching, the acquiring bank of the merchant’s choice will receive the funds. The merchant’s bank accepts a lump deposit of sales and is also responsible for deducting and distributing any fees to the companies involved in a particular transaction.

Independent Sales Organizations (ISOs)

Finally, an additional party is at times included in the big get-together. Independent Sales Organizations (ISOs) will recruit merchants to use a certain credit card processor. For bringing the processor business, they receive an additional fee, a fee that is typically passed straight down to the merchant. ISOs are never necessary to facilitate the process but often times go completely unnoticed in the fine print and confusing rates.

What Are All These Credit Card Processing Fees?

Fees are unavoidable, but they vary greatly. And some processing solutions are much better for certain businesses than others, so it’s important to know which is best for your business.

Assessment Fees

Credit card companies provide the network for the exchange and receive a smaller percentage of these fees, plus a small assessment fee. Assessment fees vary between credit card companies. For instance, VISA’s assessment is 0.11% for debit transactions and 0.13% for credit. MasterCard has a flat assessment of 0.125% for all transactions. American Express and Discover have higher fees, which is why some retailers don’t accept payments through these networks.

Interchange Fees

Interchange fees are also commonly bundled with assessment fees into “base fees.” The issuing bank receives the vast majority of the interchange fees for assuming the risk of providing the money. The merchant’s bank will send these fees to the issuing bank as soon as funds are deposited. Together, the banks and credit card companies set these rates based on an incredible number of factors. Below are just a few:

  • Card Present vs. Card Not Present (also referred to as “MOTO”) – if the card is not present, the fees will be higher.
  • High Rewards Cards – bigger benefits usually means higher interchange.
  • Swiped or EMV – EMV chip payments are much more secure and will lower your interchange rates.
  • Keyed Transactions – manually entering a card number, even if it’s present, will result in higher fees.
  • Card Type – personal, business, corporation, and municipal agency cards all have different rates.
  • Your Business Type – each business must register as a certain type of company with the IRS. Some are deemed to have a higher risk of fraud than others and are therefore subject to different interchange rates. As an example, a yoga studio would benefit to register as a school rather than a gym.

Typically, you can expect base fees to be 1.5-2% of retail sales. Some credit card processors and ISOs insist that these are non-negotiable. While they’re technically right that these fees aren’t altogether avoidable, don’t let that discourage you from doing everything you can to LOWER these fees.

Processor Fees

Credit card processors also take a percentage. This part certainly is negotiable. The lowest rates you’ll usually find are around 0.25% (this is, of course, in addition to the interchange fees). These fees can also come as a percentage of each transaction, a flat fee, or a combo of the two. Additionally, some processors bundle their fees with interchange rates, offering a simple single fee that you’ll pay. While easier to understand, these rates are almost always inflated by your processor. Lastly, ISOs, as mentioned earlier, act as liaisons between the merchant the credit card processor. Their cut is passed on to the merchant in the form of, you guessed it, additional fees.

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How Does Credit Card Processing Work with Your Retail POS System?

Your point of sale system is where all of this communication begins. A reliable POS must accept EMV payments. Under PCI compliance laws, the burden of responsibility for any fraudulent swiped transaction is on the merchant rather than the issuing bank, so EMV processors protect your business. EMV transactions, however, are the responsibility of the issuing bank. Moreover, it’s important to have a POS system that communicates quickly with all parties involved. Transactions should be fast and reliable so you can keep your long lines moving.

There are many POS solutions that also double as payment processors. While convenient for low-volume shops, these solutions typically come with fees that are well above average. An added 0.5% or even 1.0% might not seem like much, but at the end of the year, could be a pretty large sum.

So How Do You Decide Which Processing Route Is Best for Your Small Business?

Ask questions! Your processing fees all together shouldn’t be much above 2% at the most. If you get quoted more than that, find out why and how you can lower it. Don’t get locked into a POS solution that requires a long-term contract. Long-term contracts also often come with long-term processing contracts. Read the small print and ask your processor to explain it to you. And make sure you’re not dealing with an ISO. They’re good at masking their real identity. But they provide no benefit to the merchant and only cost you more money. There are plenty of ways to lower your credit card processing rates.

If you really want to get into the nitty-gritty, here are some interchange rates for VISA and MasterCard. Have fun!

Click below to find out more about the KORONA POS solution. We are NOT a payment processing company, but we can help you find one that is a good fit for your business.

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Written By

Michael Chalberg

Michael has long focused his writing on the world of retail and small businesses. He''s been a part of the KORONA POS team since 2018 and loves helping entrepreneurs find ways to adapt and succeed. In his spare time, you'll likely find him hiking somewhere in the Southwest.