How Credit Card Transactions Work

A credit card transaction is a seemingly simple process that occurs when you make a purchase using your credit card. However, behind the scenes, there are several parties involved, including you as the consumer, the merchant, the payment processor, the acquiring bank, and the issuing bank. Understanding how a credit card transaction works can provide insights into the complexity of the process and the fees associated with it.

When you engage in a credit card transaction, you typically swipe, insert, or tap your card at the point-of-sale terminal. This can be at a physical store or when inputting your credit card information online or over the phone. The payment is processed and approved or denied within seconds.

Let’s take a closer look at the roles that each party plays in a credit card transaction:

1. Consumer: As the consumer, your role is straightforward. You initiate the transaction by swiping, inserting, or tapping your credit card at the payment terminal. Once the transaction is approved, you sign the receipt and leave with your purchase.

2. Merchant: When you present your credit card at the payment terminal, the merchant’s bank, also known as the acquiring bank, is contacted for approval. The merchant’s bank then seeks authorization from your credit card network, such as Visa or Mastercard. If your card network is American Express or Discover, they serve as both the issuer and the payment network and handle their own approvals. The merchant’s bank also verifies the validity of the card and checks if there’s enough available credit to cover the purchase.

3. Payment Processor: Payment processors act as intermediaries between merchants and financial institutions. Popular payment processing companies like PayPal, Stripe, and Squarespace Commerce handle the credit card information for each transaction and facilitate the transfer of funds between the consumer and the merchant.

4. Acquiring Bank: The acquiring bank, also known as the acquirer, is the merchant’s bank responsible for arranging the payment to be deposited into the merchant’s account. In some cases, the acquiring bank and the credit card processor are the same entity. For example, if a merchant has an American Express business account and uses American Express as a credit card processor, then Amex acts as both the acquiring bank and processing company.

5. Issuing Bank: The issuing bank is the financial institution that issued your credit card. It plays a crucial role in the transaction by sending an authorization code to the merchant. To approve the purchase, the issuing bank receives your credit card number, expiration date, billing address, CVV code, and the payment amount. If the purchase is approved, the issuing bank deducts an interchange fee and transfers the funds to the merchant within one to three days.

After the transaction is completed, the merchant sends a list of the day’s credit card transactions to their bank for batch processing. The bank then directs the transactions to the appropriate payment processor, and the merchant’s account receives the deposit.

The duration of a credit card transaction varies. While you sign for your purchase and leave the store, the payment is only authorized, not immediately delivered to the merchant. It may take a few days for the charge to appear on your account, and during this time, it might show up as a pending charge.

Regarding declined transactions, a pending charge cannot be declined unless the merchant releases the funds. If a charge remains pending for a few days, it is generally due to the possibility of the merchant canceling or modifying the transaction.

Merchants incur fees for accepting credit card payments. These fees include a merchant discount fee, which is typically a percentage of the total purchase price, ranging between 2% and 3%. Additionally, merchants pay interchange fees, which are deducted from each card transaction and paid to the issuing bank, and assessment fees, also known as swipe fees, which are a percentage of each credit card brand’s total monthly sales and go to the issuers. The processing costs consist of approximately 75% to 80% interchange and assessment fees, with the remaining 20% to 25% covering markup costs for acquiring banks and processors.

In conclusion, understanding the intricacies of a credit card transaction provides insight into the roles of the consumer, merchant, payment processor, acquiring bank, and issuing bank. It also sheds light on the fees associated with credit card transactions. While you don’t need to be an expert on the process, having a basic understanding can be beneficial in comprehending the complexity and costs involved in the transaction.