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Credit Card Processing: What It Is and How It Works

Credit Card Processing: What It Is and How It Works
Jason Steele

Jason Steele

Updated August 4, 2022
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Credit card processing is something most of us never think about, but it’s key to the way our credit cards work. It involves a series of actions that deliver the money we spend to the merchants we buy from. For merchants, credit card payment processing is an extremely important part of accepting credit card payments. As a business owner, you’ll want to understand the steps and stages involved. 

How Credit Card Processing Works

When a consumer uses a credit card to buy something, that kicks off a series of events. First, the charge is authorized, which means the cardholder is given permission to make the purchase, and the merchant is given permission to accept it. Next comes the clearing process. This is when the bank issuing the card relays the transaction to the bank processing it. Finally comes the settlement of the accounts, which is when the bank issuing the card pays the processing bank, and the merchant receives the money for the purchase.  Recommended: Credit Card Terms, Explained

Stages of Credit Card Processing

There are several different components of credit card payment processing, which can help you understand the way credit cards work.

Payment Authorization

Payment authorization begins when the cardholder uses the card to make a purchase by swiping, tapping, or inserting the card if they’re paying for something in person. The cardholder can also enter the account information online, through an app, or over the phone. This is the first step in the process of how credit card payments work. 

Payment Authentication

The merchant then transmits the request for payment authorization through technology called a gateway to the payment processing company. That information is sent to the credit card network, such as Visa, Mastercard, American Express, or Discover, and presented to the bank or credit union that issued the credit card. That institution will approve or deny the request, based on whether the account is in good standing and has sufficient credit. If authorization is approved, the issuing bank will transmit the approval back through the card network to the merchant bank and, ultimately, the merchant. This process all happens in seconds. 

Clearing

After the payment has been authorized, the cardholder typically considers the transaction complete. But for the merchant, credit card processing continues. The next step is clearing, which is when the bank issuing the card transmits the transaction information to the processing bank. Settlement then occurs, and funds are moved from credit card issuers to the merchant, who is paid for the sale. 

Costs Associated With Credit Card Processing

There are substantial costs associated with credit card processing. During the settlement process, credit card processing fees are collected from the banks involved, and those fees are subtracted from the transaction. The merchant pays these fees, which are often referred to as “merchant fees” or “processing fees.” The typical merchant fee for a credit card transaction is 2 to 3% of the amount of the sale. Fees can include what’s called the interchange fee, which is the base cost of processing the transaction and the largest cost associated with the process. There’s also an assessment or service fee charged by the payment network. Finally, there is a processing fee. There are different pricing models that payment processors use, including a flat-rate model and tiered pricing. There is another model called interchange plus, which charges a percentage of the amount plus a small fixed fee per transaction. 

Selecting a Credit Card Processor

If you’re a business owner or merchant, there are several factors to consider when choosing a credit card processor. It’s similar to choosing a credit card as a consumer. First, take a look at the cost of all fees, including fees for applying and getting set up. Also, look at monthly statement fees and gateway access fees. Most important, consider interchange fees and any monthly minimum fees that may apply. Credit card processing is an extremely competitive business, so explore your options. Choosing the wrong processor can be expensive. Beyond cost alone, you should also consider whether the payment processor’s software will work with your point of sale (POS) or e-commerce system, and how easy or difficult it will be to integrate the two. Other important actors are fraud prevention and security tools. For example, you want to ensure that the processor complies with PCI-DSS (Payment Card Industry Data Security Standard) regulations, which means that merchants’ payment ecosystems are properly secured.You will also want a processor that’s compatible with newer forms of payment such as Apple Pay and Android Pay. Finally, review the processor’s customer support service because you will need reliable help when something goes wrong. Some processors offer 24/7 support, but others don’t. 

The Takeaway

There are several steps that occur in credit card processing, and it’s important to learn about each of them if you are a business owner or merchant who accepts credit cards. Understanding what’s involved, and any potential fees that may be required, can help you choose the credit card processor that makes the most sense for your business. It’s as important to choose the right credit card for your business as it is to choose the right credit card processor. Lantern by SoFi can help. Our easy comparison tool can help you explore your credit card options and make the best choice.
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Frequently Asked Questions

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About the Author

Jason Steele

Jason Steele

Jason Steele has been writing about credit cards and award travel since 2008. One of the nation's leading experts in this field, he has contributed to dozens of personal finance and travel outlets and has been widely quoted in the mainstream media.
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