Nowadays, credit cards are nearly ubiquitous in payment transactions at all levels of our economy, from tiny storefront shops to large online merchants. It has become increasingly difficult to find a consumer who prefers to pay with cash, as credit and debit cards have largely replaced old-fashioned greenbacks for the purpose of buying goods and services.

One of the primary drivers of this phenomenon is the booming popularity of online merchants that accept only electronic payments. In the not-so-distant future, it’s likely that paper money will become obsolete; in the present-day economy, it has already taken a back seat to payment cards and the incomparable convenience they offer.

What does this mean to today’s business owner? It means that if you do not accept debit and credit cards, you’re simply not competitive. Even if you run a brick-and-mortar shop with no Internet presence, your customers will expect to have the option to pay by card. A lot of consumers have fallen into the habit of not carrying any cash with them, relying on their cards to pay for everything.

Payment cards, then, are clearly the way to go, but a business owner can’t simply take other people’s credit cards and place charges on them. They need to set up what is known as a merchant account in order to facilitate credit card payments.

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Credit Card Transactions: The Main Actors

To understand merchant credit card transactions, you need to be aware of the different entities involved.

The customer – This is the individual (or organization) whose payment card is used to secure goods and/or services from a business.

The merchant – This is the business that accepts payment via debit/credit card in exchange for providing goods and services.

The issuing bank – This is the entity responsible for authorizing the transfer of funds from the customer’s account to the merchant’s. The issuing bank will be listed on the payment card (e.g., Wells Fargo) along with the credit card association (e.g., Visa).

The card processor – This is essentially the intermediary for the transaction, positioned between the bank and the merchant, and helping facilitate the transfer of funds. Leap Payments acts in this capacity for its merchant clients. The card processor—sometimes called the acquiring bank—is usually also the entity responsible for setting up a merchant account for you.credit-card-machine

The Basics of Credit Card Processing

A lot of people assume that credit card transactions are simpler than they really are. In the conventional view, the bank associated with the card merely hands over the money necessary to complete the given transaction. This view ignores the vital role of the card processor, however.

What really happens is that the card processor essentially gives the merchant a loan in the amount of the transaction, minus applicable fees (more on this later). At this point, though, the transaction has not yet been fully completed, at least as far as the merchant, card processor, and issuing bank are concerned. That’s because, by law, consumers have to right to ask for a chargeback within a certain period of time. There are a number of reasons why chargebacks happen: credit card fraud, defective merchandise, or failure of the merchant to deliver goods or services requested, to name a few.

Here’s one nightmare theoretical scenario for a card processor. Let’s say a small business allows thousands of customers to purchase a certain mail-order item by credit card. The card processor, holding up its end of the deal, transfers all those customers’ funds to the merchant account. The merchant, however, subsequently fails to deliver the items its customers ordered. In fact, the business simply closes down, and its owners flee to parts unknown with their customers’ money.

Under this scenario, the business’s customers will be permitted to request chargebacks, as they never received the item they ordered. So, who is “on the hook” for all that money? The card processor—which cannot recover the funds from the now-defunct business.

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Merchant Accounts and Fees

The above example illustrates an important point about card processors: They assume significant financial risk by doing business with merchants. When a card processor handles a given business’s transactions, the processor is basically extending a line of credit. It has to bear the dangers involved in paying out money without a guarantee that the money will not need to be refunded at a later date, due to chargebacks, warranty claims, or another reason. The processor, therefore, may end up accepting the ultimate responsibility for these transactions.

As a result, the card processor has to take steps to offset this risk as far as reasonably possible. One of these steps involves an application process where the card processor evaluates the credit-worthiness of a business prior to deciding whether to set up a merchant account with them.

Some kinds of businesses are commonly believed to pose a substantially higher risk than the norm and often get rejected when they apply for merchant accounts; these include travel agencies, gun dealers, and casinos. Risk is never entirely absent from card processing transactions, however, and this simple fact accounts, to a large extent, for the kinds of fees and policies that processors impose on their clients.

The risk evaluation and mitigation process does not end after a card processor has approved a client for a merchant account. Card processors charge appropriate fees for each type of transaction that they manage. These fees are controversial among many in the business community who feel that card processors are merely finding excuses to squeeze more money out of their clients.

Certainly it’s true that a number of shady card processors make a habit out of piling on gratuitous charges, which is why it’s important to perform due diligence when selecting a processor—a good one will be an invaluable business partner; a poor one will drain your bank account and inflict endless headaches.

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Types of Card Processing Fees

Processing fees simply come with the territory if you are going to offer credit card payment options to your customers. Let’s take a look at the fees commonly encountered by today’s businesses.

Transaction fees – Each time you run a customer’s payment card, whether online or in person, you will incur a transaction fee of some kind. Transaction fees include interchange fees, which are set by the credit card associations, and usually are calculated as a percentage of an accepted transaction. Interchange fees vary according to the card type and risk level of a transaction.

For example, Card Present transactions (where the customer runs the card through a POS terminal or hands it to the cashier) are lower than Card Not Present transactions (where the customer inputs the numbers in an online form). That’s because Card Not Present transactions are the riskier of the two, as they’re more likely to be fraudulent—you don’t even need to have possession of the physical card in order to execute one of these transaction.

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Transaction fees comprise the largest single expense involved in maintaining a merchant account.

Per-incident fees – These are fees associated with specific card processing actions. Chargeback fees are probably the most notorious of these, and cause headaches for card-accepting businesses and processors alike. Batch fees, which are incurred when the company sends the day’s transactions to the processor, also belong in this category.

Flat fees – An assortment of miscellaneous fees and charges fall under this category: set-up fees, annual fees, equipment leasing fees, gateway fees, next day funding fees, and many others. This is where a lot of dubious charges tend to show up if you’re dealing with a fly-by-night card processor. That’s why it’s important to deal only with established, reputable processors such as Leap Payments—we provide clear, easy-to-understand monthly statements that let you know exactly what you’re paying for.