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What is credit card processing | How Credit Card Processing Works

How Credit Card Processing Works

What is credit card processing | How does Credit Card Processing Works?

Are you having trouble understanding your merchant account are you confused about the rates and fees and how you're being charged if so

This article will explain how it all works you don't need to know every little detail about credit card processing 

you just need to know enough to delegate the task to a provider that'll take care of everything for you 

nevertheless, it's important to understand the fundamentals so that you can properly make a provider selection.

  1. What is the merchant account transaction cycle and how it works
  2. Interchange and its role in the process 
  3. The two main pricing structures and how they compare to each other.

1. What is the transaction cycle?

First, the customer presents a card to the merchant for purchase of goods or services after the card is swiped are entered into the point of sale software the processor sends out for authorization through the payment processing network

The issuing bank approves or declines the transaction based on funds available the transaction is then passed through the electronic networks to the processor and the approval code is delivered to the point-of-sale device at the merchant location 

The Issuing Bank then sends the money to the processing company to reimburse them for the purchase that was made this whole process is completed in just a matter of seconds 

At the end of the day, the merchant will send out all of their transactions referred to as a batch to the processor for monies to be deposited into the merchant bank account and finally, the issuing bank will send the cardholder a bill for the purchase.

2. What is an interchange and what role does it play?

Interchange is scheduled fees that determine the price for all credit card transactions there are hundreds of interchange levels and each is comprised of a set of qualification requirements that must be met in order for a transaction to fall into a certain category, the two main qualification requirements are.

Number one:- How the payment is accepted whether it's face to face or over the phone.

Number second:- The type of card that is used whether it's a consumer card or a business card.

Individual rate categories are set by Visa and MasterCard and the interchange scheduled fees are published and could potentially change two times per year 

This is important to remember since those changes can affect the cost of your merchant account here's a sample of just one part of a schedule of fees published by Visa.


As you can see there are 10 rates and eight categories on this example alone again in any single transaction just one of these rates are charged based on the qualification of the card that was presented.

Two main pricing models and the components of both of them most providers will offer the following price structures.

Number One: Tiered pricing also known as bundled or bucket pricing.

Number Two: Interchange Plus is also known as cost-plus or pass-through pricing.

Interchange costs are at the core of both pricing models the fees for any given transaction are broken down into two main categories 

Interchange costs along with dues and assessments and processor costs dues and assessments are paid to the card networks which is Visa and MasterCard and are the same for everyone as our interchange costs 

They are absolute and every processing company pays the same amount for interchange dues and assessments period they cannot be changed or discounted for special situations or for any reason 

So whether you're a Fortune 500 company processing billions of dollars each year or a hobby business with just a couple thousand dollars in volume you pay the same fees.

Interchange it is assumed that dues and assessments are included since we understand that they are the same for everyone the processor cost is the one variable that differs from one processor to the next and is the only area open for negotiation in your search for a merchant account provider.

Tiered pricing or interchange plus tiered pricing takes hundreds of interchange categories and lumps them into bundles or buckets the three common tiers are qualified, mid-qualified and non-qualified and as you can see from the chart the rates increase as you move from qualified to non qualified 

Each of these tiers is set and assigned a specific rate by the processing company and can vary from one provider to the next in fact they often do what is considered to be a qualified transaction with the provider a might fall into a mid-qualified transaction with the provider-B 

Tier pricing sorts the hundreds of interchange categories and each tier is priced high enough to cover the average of all of the rates and fees that fall under that tier interchange-plus pricing passes 

The actual interchange cost through to you and a small provider charge is charged in addition also referred to as provider markup this fee varies widely based on a variety of factors and can range from five basis points up to 1.5% or even higher.

Here's a sample transaction refer to the visa interchange chart that we looked at earlier and let's compare a single transaction at a qualified rate of one point seven nine under a tier-based program to an interchange-plus pricing program with a processor costs of 20 basis points.

Assume the following for the transaction the interchange cost is 1.65% plus a 10-cent transaction fee and we'll use a hundred dollar transaction as the sample dollar amount 

Given those two variables, we know that the actual cost of the transaction is one dollar and 75 cents for the interchange-plus pricing model you have a 20 basis point added to the one dollar and 75 cents actual cost bringing the total to one dollar and 95 cents. 

For the tier-based pricing model you have that same base cost of one dollar and 75 cents but in order to get the total cost for a tier-based pricing model you simply multiply the hundred dollars times the 1.79% rate assigned to that tier level to get the dollar and 79 cents total cost.

Interchange costs is at the core of each of these pricing models and with any pricing model for that matter and is paid one way or another 

With the interchange-plus pricing model, your total cost is one dollar ninety-five cents compared to the one dollar and seventy-nine cents with the tier-based model 

Only a small piece of the total fee is paid to the processor as most of the fee is sent back to the issuing bank provider costs are collected for the purpose of paying Network fees and other general business costs 

Such as administrative expenses associated with accountant servicing application approval and costs related to licensing the electronic payment networks 

For each transaction, this same calculation is done depending on the pricing model that you're currently paying 

It's widely assumed that interchange plus pricing is a better pricing model because it's said to have a true cost or a transparent pricing model but does not necessarily mean that it's a lower overall cost 

Variables such as average ticket and the number of transactions processed each month in addition to the pricing structure variables that we discussed already determine whether tear or interchange plus pricing is best for your company merchant account pricing is not one-size-fits-all 


What matters the most is the total dollar amount and fees paid for accepting a certain dollar amount of credit card volume.

Source: What is credit card processing 



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