What is credit card processing and how does it work?    
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October 2, 2023

What is Credit Card Processing and How Does it Work?

  • February 8, 2022
  • 4 min read
What is Credit Card Processing and How Does it Work?

Credit card processing is a service that enables retailers and merchants to accept credit cards as payment. When you swipe your credit card at the grocery store, or when you buy something online, these are both examples of credit card transactions. When you are applying for a credit card, you should also check when do credit card companies report to credit bureaus.

The way this works is that retail businesses use equipment provided by their merchant services providers to process their customers’ credit card transactions. This equipment takes the information from your credit card, processes it through a card network, and sends it to your customer’s bank so that the funds are transferred.

How this works is that at first, It starts with swiping of credit cards on credit card processing equipment which reads the identification number of the card. Some merchants prefer to manually type in credit card information instead of swiping because, for them, it is easier and more convenient.

Credit card processing equipment captures the account number and other information encoded on the magnetic stripe on an individual’s credit card. After reading the credit card number, the system confirms that this number matches with a valid account by checking it against a database that lists all of the valid credit card numbers.

Next is the transaction code, an algorithm that determines whether or not purchase can proceed. It all depends on what you are purchasing with your credit card. For example, if you are buying gasoline then this algorithm ensures that there is enough funds in your account to cover the charge. If there is not enough money in your account to cover the total purchase, then the transaction will not be approved. The reason for this is that if this algorithm was left out or say it was faulty, merchants could potentially make purchases on anyone’s card without their permission.

The next step involves the transaction amount which first must be confirmed with you, the consumer. If you are buying something at a brick-and-mortar store, then this step involves having you initial or sign the receipt. If you are making an online purchase then this step just involves your inputting your password to verify that you are who you say you are.

Once the credit card processing equipment has all of this information it forwards this information to the card network which then forwards it to your bank. In order for a merchant to accept credit cards as payment, they must sign up with a merchant services provider and open a line of credit – called a credit limit.

The merchant’s account is then credited with the amount of the transaction minus a fee that goes to the merchant services provider and ultimately to the credit card networks. The fee is usually processed as a flat rate for each transaction and it can vary from 2 to 4 percent depending on the network and the type of merchant.

The processing fees depend on:

  • Interchange rates: Different types of cards have varying fees that are based on their interchange rates. For example, credit cards have higher fees than debit cards.
  • Merchant type: Some businesses, like gas stations and restaurants, typically pay lower rates because they are considered high risk. Retail stores pay the highest rates in this category.
  • Credit card company: For example American Express charges merchants more in processing fees compared to Visa or MasterCard because additional clearing and settling is required.
  • Your credit limit: The more available credit you have, the lower your processing fees will be. This is because it makes you a less risky transaction for the merchant services provider to process transactions from you. So basically merchants are not as likely to cancel your payment or return the product if they aren’t sure that you have the funds in your account to cover a purchase.