How Do Payments Work?
February 5th, 2019

For small business owners and businesses that pay for products and services at merchants, understanding how credit card payments work is vital. If you’re like most businesses in the US, payment processing is one of the biggest operating expenses you face. And, in the non-transparent, fee-ridden credit card processing industry, even a basic understanding of the process will empower many business owners to find cost savings.

The process appears fairly simple and straightforward, right? Customers swipe, dip or tap their cards, within a matter of seconds the transaction is either approved or declined, and within 24 to 48 hours the money transfers into your account. But, the swipe or dip of a card is only the first step in an elaborate process that involves several parties, steps, and potential fees.

Below, we will explore the process that takes place with every card transaction:

The 5 Parties of a Credit Card Transaction

There are five key players in every credit card transaction. Becoming familiar with each, and being conscious of the roles they play, will aid in your understanding of how credit card payments work.

    • Cardholders – Individuals
    • Merchants – These are businesses who accept card payments from cardholders in exchange for goods or services. If you are a business owner that accepts card payments, then this is where you fit into the process.
    • Acquiring Bank – An acquiring bank, or acquirer, contracts with merchants to accept card payments. Acquirers receive authorization requests from the merchant and forward them to the card associations.
    • Card Associations – These companies operate global networks that process electronic card payments. Card associations function as a relay, exchanging transaction information and funds between acquiring banks and issuing banks. Examples are Visa, Mastercard, Discover and American Express.
    • Issuing Bank – An issuing bank is a financial institution, such as Bank of America, Wells Fargo or Citi Bank, that issues credit cards to the cardholders. It receives authorization requests from the card association, verifies the account and credit details, and either approves or declines payment.

The Credit Card Payment Process

There are two main stages of the credit card process: the authorization stage, which happens during the seconds following the swipe of a card, and the clearing and settlement stage, which happens on the backend at the end of a business day.

Stage One – Authorization

During this first stage, the merchant must make an authorization request to the issuing bank and receive approval for the credit card purchase. An authorization request typically includes the card number, expiration date, billing address (for address verification), card security code, and payment amount. Here’s the steps that take place during the authorization stage:

  1. The cardholder makes a purchase from a merchant and presents a card for payment.
  2. The merchant collects information from the cardholder’s card, which is done through a POS device by having the customer swipe, dip or tap their card, and sends an authorization request to the acquiring bank. (Alternately, merchants manually enter the card information through an online terminal, though this will incur a higher interchange fee.)
  3. The acquirer forwards the request and credit card information to the credit card association.
  4. The credit card association relays the request to the issuing bank.
  5. The issuing bank authorizes the transaction if there is valid credit and sends an authorization response to the acquiring bank via the card association.
  6. The acquirer returns the authorization code (approved/declined) to the merchant.
  7. The merchant receives the authorization and completes the transaction with the cardholder.

Stage Two – Clearing and Settlement

At this point, the transaction is complete, but no funds have changed hands. The merchant, acquiring bank, card association and issuing bank still need to be paid for the transaction. Here’s what happens during the clearing and settlement stage:

  1. At the end of the day, the merchant groups the authorized transactions together in a batch and sends it to the acquiring bank to receive payment.
  2. The acquiring bank distributes the batch to the various card associations to request payment from the issuer.
  3. The association distributes the transaction information to the appropriate issuing bank.
  4. The issuer transfers the transaction amount, minus the interchange fees, to the card association.
  5. The card association receives the transaction amount and subtracts its association fee before routing the amount to the acquiring bank.
  6. The acquiring bank subtracts its “merchant discount rate” from the transaction amount and credits the remainder to the the merchant’s account.
  7. The issuing bank bills the cardholder for the amount of the transaction, and the cardholder pays for the transaction.

A Word About Fees

During the clearing and settlement stage, the merchant pays a fee, or merchant discount rate, to process each card transaction. It’s typically between 2% and 3% of the total transaction amount and consists of the interchange fee, the association fee, and markups.

The interchange fee and association fee are set rates determined by the individual card associations and are payments to the issuing bank and card association, respectively.  Together, they account for roughly 80% of the processing cost for merchants and are not negotiable rates. Don’t even try. It isn’t worth the time or effort.

All acquiring banks charge an additional markup to the interchange rate and association fee to cover the cost of processing and make a profit. The markup comprises monthly fees, annual fees, statement fees, reporting fees, software fees and equipment rental fees, and numerous other incidental fees. Many of these fees are negotiable.

Take Control of Your Processing Fees

By taking the time to understand how credit card processing works and finding the right processing company, you can find substantial cost savings to add to your bottomline.

If you’re curious to learn more about how Sonder Payments can help your business pay lower credit card processing fees, contact a Sonder Payments representative by emailing or by calling (314) 722-6424.