How Credit Card Transaction Processing Works: A Complete Guide

Understanding how credit card transaction processing works is vital for any business that accepts payments. Whether you’re accepting e-commerce payments, managing subscriptions and recurring payments, or accepting payments in person, understanding how the process works can assist you in safeguarding your business, resolving issues more efficiently when they arise, and ensuring the security of your customers’ data.

Today, digital-first and omnichannel businesses make online payments and recurring business models more common than ever. As these trends continue, a functional understanding of the payment process can help you ensure your business runs smoothly and is prepared to stay updated with industry changes.

In this guide, you’ll explore the entire credit card transaction process from start to finish, learn how key players interact, and get strategies for managing fees and reducing risks that drive up your business costs.

What are the different types of credit card processing and transactions?

Think about a typical week in your life. How many card transactions do you initiate and complete? That includes everything from swiping your card at your local café for your morning coffee, ordering necessities from Amazon, a quick trip to the grocery store for food, and more. That list gets even longer when you include automated recurring transactions like streaming services, cloud storage accounts and app subscriptions.

The world processes millions of credit card transactions daily, and most transactions begin and are completed within seconds. In today’s digital landscape, businesses and customers alike rely on fast, secure transactions. Most of the time, transactions are completed without incident. However, each transaction type does come with its risks and challenges:

	How it Works	Key Challenges
In-Store Payments	A customer physically swipes or taps their card at a payment terminal	Need reliable equipment and secure connections
Online Credit Card Processing	A customer enters their card details on a website or app to authorize a payment	Websites that accept payments need elevated security, including encryption, to prevent fraud
Recurring Payments	A customer authorizes a recurring payment for a subscription	Billing errors, expired cards and customer disputes often interrupt the flow of payments

Understanding how transaction processing works can help you reduce risks and manage these challenges when they arise for efficient resolution.

What is the cost of accepting credit card transactions?

Like everything else in business, accepting credit card payments comes with costs. Understanding those costs and how they impact your bottom line is essential to keeping your budget in check. There are two types of fees to keep in mind:

Interchange fees are fees paid by the merchant’s bank to the customer’s bank each time a transaction is completed. Usually, this is a small percentage of the transaction plus a flat fee. Payment networks (like Visa and Mastercard) set these fees and use them to help cover the payment processing risk. These fees vary depending on the type of card used (for example, rewards cards often have higher interchange fees) and the type of transaction. In the United States, these fees are typically around 2%.[1]

 The payment processor charges processing fees to facilitate the transaction. Since payment processors also provide security measures like encryption and fraud detection and help your business achieve PCI compliance, these fees are necessary to keep processors and gateways up to date to mitigate security threats, keep costs low and maintain the infrastructure. [2]

These costs can add up, eating into a business’ profit for each transaction. One of the best strategies for mitigating these costs is to compare payment processors and ensure you get the best rates and features for your business. Look for payment processors that provide transparent pricing and low monthly fees to keep your cost-per-transaction as low as possible, without sacrificing functionality and payment security.

What is a chargeback?

We can’t discuss the cost of accepting card payments without acknowledging chargebacks. Unlike standard fees, which are routine costs of accepting credit card payments, chargebacks represent a possible financial loss for businesses.

A chargeback occurs when a customer disputes a transaction, resulting in a reversal of the payment. Some common reasons for chargebacks include fraudulent transactions, billing errors, unfulfilled orders, and customer dissatisfaction. Businesses accepting recurring payments can also be the target of chargeback disputes when their transaction descriptors are unclear, and the customer does not recognize the charge.

When the customer files a dispute, their bank investigates the charge and may issue credit to the customer. The merchant is notified and can dispute the chargeback, but the bank decides whether to uphold the chargeback and reverse the transaction. If the bank decides in favor of the customer, the business loses the sale amount plus a chargeback fee.

Learn more about chargebacks and how to protect your business and revenue from disputes in our recent article, Chargeback Defense: Protecting Your Subscription Business in 2024

Who are the players in credit card payment processing?

While credit card transactions are quick and convenient for customers and merchants, processing payments involves multiple players interacting through complex technical protocols.

Key Players:

• The Customer: The individual using their card to make a purchase
• The Merchant: The business accepting the payment
• Issuing Bank: The customer’s bank that has issued the credit card and approves or rejects the transaction
• Merchant/Acquiring Bank: The business’ bank that manages the merchant account and processes payments the business receives
• Card Networks: Networks like Visa, Mastercard and American Express facilitate communication between the Issuing Bank and Merchant/Acquiring Bank
• Payment Processor: The intermediary that moves transaction data between the merchant, card networks and banks to ensure the transaction is approved and funds are transferred successfully and securely
• Payment Gateway: The software that secures transaction details and transmits them between the customer and payment processor

Together, these players ensure the seamless, secure transactions that drive business.

What are the steps in credit card transaction processing?

Each of these payment players works together throughout the process to process a credit card transaction:

• The customer submits a payment using their credit card
• The merchant sends the payment information to their chosen payment processor
• The payment processor passes that data through the card network to the customer’s issuing bank
• The issuing bank approves or declines the transaction and informs the merchant bank
• If the transaction has been approved, the issuing bank sends the funds to the merchant bank to be deposited in the merchant account.

These interactions take place through a structured, 4-part process that each transaction follows:

Step 1: Payment

The customer submits their payment information, and their issuing bank ensures the credit or funds are available to the customer and authorizes or declines the transaction.

Step 2: Batching

At the close of business each day, the merchant’s payment gateway submits customers’ transaction data through the processor to the merchant bank for payment.

Step 3: Clearing

The merchant bank accepts deposits from the processor and distributes the transactions to the appropriate issuing banks, who then debit the amount from the customer’s account.

Step 4: Funding and Settlement

The issuing bank sends the payment information back through the network to the merchant bank, which transfers the funds into the merchant account, completing the transaction.

What is a payment gateway, and why do businesses need one?

This is one of the most common questions we hear at Payway.

A payment gateway is a service that allows businesses to process credit card authorizations and transactions. It provides a set of connections and security features that enable businesses to access the systems they need to process a transaction from start to finish. From the moment the card information is entered, the gateway transmits the information through the processor to the issuer for authorization.

Without a gateway, businesses can’t access the necessary processors to accept and complete card transactions.

What does the future of credit card transaction processing look like?

Our experts at Payway are monitoring several emerging trends that will shape credit card processing as we enter the second half of the decade, including:

• Increasing use of mobile and contactless payments
• Rise of wearable payment technologies (like smartwatches)
• Enhanced security measures like tokenization and biometric authentication
• Increasing adoption of buy-now-pay-later (BNPL) models

As these technologies evolve and become more common for customers, businesses must adapt to continue meeting customer demands and providing secure, efficient credit card transactions.

As you look towards the future of your business, take a proactive approach to staying secure. Consider reviewing your payment systems to ensure they’re cost-effective, and re-evaluate your payment gateway and processor to ensure you’re not spending more than necessary on fees.

Need help starting the process? Payway provides free cost analysis and transparent cost-plus pricing, so you’ll always know what you’re paying for each transaction. Feel free to contact our sales team with questions or explore the critical features, security, and concierge support Payway offers.

 

 

 

 

[1] Interchange fees: what they are and how they work – Adyen

[2]  What are Processing Fees – Processing Fee Definition (synder.com)