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Tuesday, September 28, 2021

How Credit Card Processing Works: An Ultimate Coordinating Guide for Merchants

Credit card processing is a notoriously tricky aspect of running a business. Small business owners have a remarkable amount of operational details to manage. For too many, credit card processing takes a lengthy turn on the back burner.

To be fair, it’s complicated and boring. No one started a business with the hopes of negotiating rates with their merchant service provider. Nonetheless, small businesses are spending billions of dollars each year on card processing. And a portion of those fees is avoidable.

With that in mind, let’s go through the basics of how credit card processing works. We’ll stay out of the weeds but cover enough so that any business owner can know what to look for, the right questions to ask and find the lowest rate available, and also the importance of small businesses accepting credit card payments by a reader app.

Who Are the Players in the Processing Game?

Before we get into anything else, let’s go over who’s involved in the process. Some transactions add a few additional steps, but for the most part, the same entities will be involved.

  • The customer: No transaction can be complete without the customer making a purchase.
  • The merchant: The merchant accepts the payment through the credit card machine or online payment gateway.
  • The credit card processor: Also referred to as a merchant service provider, the processor is responsible for keeping the transaction efficient and secure.
  • The ISO: Independent sales operators, or, resellers, are third-parties that sell processing solutions on behalf of the processing company. They serve as a middleman and are NOT a requisite part of the process.
  • The card network: These are the credit card companies and might also be referred to as card associations. They include the big four: VISA, MasterCard, Discover, and American Express.
  • The issuing bank: The issuing bank is on the customer side. They’re responsible for approving/declining the transaction.
  • The acquiring bank: On the merchant side, the acquiring bank accepts the payment transfer from the issuing bank.
  • The payment gateway: For online transactions, payment gateways are a necessary addition to ensure a secure eCommerce purchase.

How Does a Credit Card Processing Work Each Transaction?

Each transaction follows a series of steps that are completed in just a few seconds. Despite the short time interval, these steps are remarkably complex. 

Step 1: The customer swipes, dips, taps, or keys in the card to make a payment.

Step 2: A credit card terminal or payment gateway sends the request to the credit card processor.

Step 3: The processor sends the transaction information to the appropriate card network to assess an interchange fee.

Step 4: Simultaneously, the processor sends the transaction data to the issuing bank.

Step 5: The issuing bank analyzes the transaction to determine if there was any fraudulent behaviour and if there are sufficient funds. They will send an approved or declined message in response.

Step 6: Money is then deposited from the issuing bank to the acquiring bank. This step may not be fully completed for 1-3 business days.

Step 7: Prior to the total transaction value being deposited, the credit card processor may deduct any charges owed for the service (certain pricing structures circumvent this step).

There are some exceptions to these steps, but this is the standard process for any normal transaction. It’s meant to ensure that the customer has the required amount to make any purchase, ensure that the merchant receives the money, keep the customer’s data protected, and reward the parties that facilitated the process a small fee.

What Are the Fees Involved?

So this is where things get a little murkier. The industry doesn’t have a reputation for transparency and fees can get confusing. Still, as you’ll see, it should be simple enough.

Interchange Fee

The majority of any processing fee is its interchange rate. These rates are determined by the credit card networks and vary based on the type of transaction. The higher the risk of the transaction, the higher the interchange fee will be.

For instance, a $3 debit card transaction using dynamic EMV technology at a gas station will have a far lower interchange fee than a $1,500 online purchase with a high-rewards credit card. 

Risk is based on many factors. The most prominent is the type of card being used, the way the card information was entered, the amount being charged, and the type of business, which is accepting the transaction. Once assessed, interchange fees are dispersed to numerous parties, but most of them go to the issuing bank for assuming the inherent risk of the transaction.

Network Fees

For setting the interchange fees, the card networks also take a cut of each transaction. These institutions are responsible for regulating the market and maintaining a high level of trust among consumers and merchants.

Each card network has unique interchange rates based on various factors. American Express, for instance, has higher interchange rates than its competitors. This is why some retailers opt to not accept American Express cards.

These fees are non-negotiable but they generally comprise less than a tenth of the total transaction fee.

Processor Fees

Your merchant service provider also needs to be compensated for facilitating the transaction. In addition to allowing each party to communicate, a merchant service provider also ensures that your business is following all compliance standards. This adds security to the process and helps the merchant avoid fines.

These fees are negotiable and vary widely by the processor. If an ISO is selling the processing, the fees will be more expensive.

Your merchant service provider also needs to be compensated for facilitating the transaction. A merchant service provider will create a unique merchant id number for your business, and in addition to allowing each party to communicate, will also ensure that your business is following all compliance standards. This adds security to the process and helps the merchant avoid fines.

Additional Fees

Merchants can get hit by a LOT of additional fees. Good processing solutions will minimize these, though some are unavoidable. Below is a handful of the most common:

  • Hardware rental
  • Customer support
  • Chargebacks
  • Online payment gateways
  • Card minimums
  • Cancellation
  • Batching

None of these is necessarily standard. When shopping for a processing solution be sure to ask what fees they may assess. They should be able to provide an itemized breakdown of how they bill. This provides merchants with adequate transparency.

Wholesale and Markup Fees

Lastly, you may see mention of wholesale and markup fees. These are broad terms to describe non-negotiable and negotiable fees respectively. 

An example of a wholesale fee might be the card network fee, while a markup fee might be a chargeback penalty.

Are There Different Types of Processing Pricing?

Merchant service providers have created several different types of processing plans. While there are some pros and cons to each, the interchange-plus model is typically the most transparent and fair. 


  • The interchange rate is kept independent of all other fees
  • Itemizes all wholesale and markup fees
  • Offers the most transparency


  • Costs are determined by a tiered program of qualification
  • Lower qualification means higher processing prices
  • Complex and non-negotiable
  • Lacks transparency
  • Bundled rates


  • Separates wholesale and markup
  • All markup fees are bundled into a single monthly cost
  • A good solution for businesses with a high average transaction value
  • Adequate transparency on costs


  • Simplest structure
  • Lacks transparency
  • Fees bundled into one monthly rate
  • No negotiation

How Can Small Businesses Lower Processing Rates?

Though there is no way of completely eliminating your credit card processing fees, it is possible to significantly lower them. For businesses that have a high transaction volume, even dropping them just a fraction of a percentage point can save you thousands of dollars each year.

Stay Away From Bundled Deals

These credit card processing structures offer low transparency and often include surcharges and additional fees without you even knowing. Look for plans that itemize each part of the final processing charge.

Negotiate With Your Merchant Service Provider

Despite what they might want you to think, credit card companies will budge on their rates. Shop around, get competitive quotes, and go with the lowest rate. Ask each for a cost breakdown analysis, too. This will show you exactly what you’re paying for.

Reduce Risk of Fraud

A higher chance of fraud means a higher processing rate. Prove to your processor that you have taken steps to lower instances of fraud. Follow PCI compliance rules, require EMV payments, minimize chargeback, require signatures on deliveries, and more.

Use an Address Verification Service

This verifies the customer’s billing address with the issuing bank to make sure all online orders are being delivered to the address of the cardholder.

Set Minimum Transaction Amounts

With certain pricing structures, small purchases will come with a higher percent processing fee. You want to add convenience to the shopping experience, but many stores so require a minimum purchase amount to use a card.

Get Modern Payment Terminals

It’s required for nearly all U.S. businesses to have EMV compatible credit card machines. Add contactless options, too. This reduces the risk of fraud and keeps your store more secure.

Batch Transactions Regularly

Batch all credit and debit transactions at the end of each business day. It reduces errors and lowers your fees.

Get a Versatile Point of Sale

Too many POS solutions come with lengthy and costly credit card processing agreements. Instead, look for a POS system that offers choice with your processing. This allows you to shop for the best solution and to make a switch in processing at any point. Great solutions will actively work with you to find the most affordable and reliable option.


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Kiara Dawson
Kiara Dawson comes from an Engineering background, with a specialization in Information Technology. She has a keen interest and expertise in Web Development, Data Analytics, and Research. She trusts in the process of growth through knowledge and hard work.

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