How does a credit card transaction work?


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Every time you swipe (or insert, or tap) your credit card, there is a series of events that follow to ensure your money gets from your bank account to the merchant, with several stops along the way.

Each of these steps in the process helps determine how much you pay for a good or service and how much income the merchant and banks involved collect along the way. Next time you make a purchase with your credit card or make a payment towards your statement balance, consider these steps put into action after you leave your signature on the keypad.

The process

In order to understand how credit card transactions work, it helps to understand all the actors involved, many of which you should already be familiar with. These include:

  • You, the cardholder
  • The merchant enabling the transaction
  • The issuing bank of your credit card (Chase, Bank of America, etc.)
  • The merchant bank, or acquiring bank, which enables the merchant to accept debit and credit card payments (this may also be a processor like Square) through a point-of-sale system
  • The network which facilitates communication between the issuing bank and acquiring bank (Visa, Mastercard, Discover and American Express are the only networks)

When you insert your card into a merchant’s card reader, that merchant’s bank (the acquiring bank) requests information from your issuing bank (your card issuer) to determine whether you have enough available credit for the purchase. This is all facilitated through the network your card is processed through (like Visa or Mastercard).

Once the acquiring bank has approval, the transaction can be completed between you and the merchant and you receive receipt of the sale.

After the initial transaction is done, the behind-the-scenes movements between institutions begins. Your card issuer sends the funds (again through the network) to the acquiring bank and the acquiring bank, in turn, will deposit that amount into the merchant’s account. Each bank will take a cut in fees along the way.

The amount is recorded onto your credit card statement, which you will then pay back to your issuing bank at the end of the statement period.

It’s important to note that the banks involved in the transaction process may play multiple roles. For instance, you may have a credit card issued by Chase, while the merchant you’re buying from also uses Chase’s Merchant Services as its acquiring bank.

Breaking down fees

Using credit cards to make and process payments costs money, in addition to the cost of your actual purchase. This is how, in part, your issuer subsidizes the cost of rewards and benefits you, or cardholders of more premium rewards cards, earn. Regular fees you pay to your issuer, separate from individual transactions like annual fees and interest payments, also help make up the cost of rewards.

Transaction fees are highly variable and may be dependent on negotiated contract agreements, purchase volume and other individual factors. Here are just a few examples of fees that may impact your purchases.

Interchange fees

Interchange fees are market-based. The percentage is established based on several criteria by the network (like Visa or Mastercard) but paid by the acquiring bank and processor to the issuing bank. These fees make up the bulk of fees charged on any given transaction.

Network assessment fees

Before the funds (minus interchange fees) are wired to the merchant’s acquiring bank, the network also takes a cut, in exchange for facilitating the transaction. Network assessment fees are fixed rates and may be charged whether the transaction is ultimately approved or declined.

Merchant discount rate

The merchant ends up taking on the real costs of fees, rather than any of the banks. When the merchant’s acquiring bank transfers the money owed from a customer’s transaction, the bank keeps a portion previously agreed upon in the terms of the contract between the merchant and acquiring bank. This is typically sufficient in covering the cost of interchange and network assessment fees, as well as the acquiring bank’s share.

Merchants are still in the business of minimizing costs, though, which is why customers often end up eating fees in the form of price markups, where costs are built into the price of each good or service. It’s also why some merchants may only allow certain types of credit cards, require a minimum payment to use a card or simply take cash only.

This is far from an exhaustive list of the fees that any given transaction may incur, but you can gain a sense of how each actor benefits from your purchase when you use your credit card.

Why you may get declined

During the transaction process, your purchase may be disrupted, leading to your card being declined by the merchant.

While many tend to think declines are primarily due to a maxed out card, it can occur because of anything from incorrect card information or technical issues on the part of one of the banks involved in the transaction. You could also find your card declined if you attempt to make a purchase from a location you haven’t cleared with your issuer or if you make a large number of purchases within a short time, both as fraud prevention measures.

Why is this important?

Understanding the transaction process can help you become more familiar with why goods and services are priced the way they are as well as how you’re able to earn high sign-up bonuses and rewards rates on your premium credit cards.

The more people use cards with higher merchant fees, the greater chance that any given merchant will increase its prices to make up the difference or refuse to accept cards with those high fees.

Those who pay with cash or debit cards usually end up taking the fall for fees incurred, since they pay the same merchant markups but don’t earn rewards on their transactions. If you pay the same amount as someone who earns 2 percent back on the transaction with the merchant, but you pay in cash, you will always be the one to take on the cost in the end.

It can often be most beneficial to you as a customer to use a rewards credit card when you make a purchase, as long as you pay your balances in full and on time each month so you don’t end up paying fees, too.