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How Does a Payment Processor Work?

In recent years, consumers have been more and more likely to choose credit cards when asked at the point of purchase. In 2019, people used cash in just 26% of transactions — two years prior, people used cash for 30% of purchases. At the same time, credit card use inched upward from 2017 to 2019, accounting for 23% of purchases, while debit cards had the largest share of transactions at 28%. 

One of the reasons cash has held on for so long is that it’s easy for businesses to accept and for people to acquire. If a customer pays in cash, all they have to do is hand over the money. If they want to pay with a card or digital method, such as a contactless payment program installed on their phone, a third party needs to enter the picture. That third party is a payment processor.


Who's Who in the Payment Process

Before we take a closer look at how payment systems work, it’s worth getting to know the cast of characters in the payment process. Knowing who’s who is key to understanding what happens when you accept a credit or debit card or another form of electronic payment from a customer. Here are the six players in the payment process:

1. Merchant

The merchant is the company accepting the payment and selling a product or service to a customer. If you own a business that sells products or services to consumers, you’re the merchant.


Both online stores and brick-and-mortar shops are merchants. Even companies you might not typically think of as merchants, such as medical providers, travel agents or life coaches, fall under the category, as long as they are the party accepting the payment.

2. Cardholder

The cardholder is the individual or business that has the account associated with the payment method. The cardholder may or may not be the same as the person who is making the purchase. For example, a parent might hand their credit card to their child and have them order a pair of shoes online or use the card to pay for dinner at a restaurant. Similarly, a business might issue cards to certain employees to use to make work-related purchases.

3. Acquiring Bank

The acquiring bank is the bank that works for the merchant. When a merchant partners with an acquiring bank, it gets a merchant account, which grants it access to a line of credit. Sometimes known as merchant banks, an acquiring bank sends payment requests from the merchant to the issuing bank during a transaction.

4. Payment Processor

The payment processor, also known as a service provider, may or may not be part of the acquiring bank. In some cases, a third party provides the service and hardware a merchant needs to accept card or electronic payments. The payment processor also sends payment details over to the credit card network.

5. Association Member or Credit Card Network

Visa, MasterCard, American Express — you’re likely familiar with the most well-known credit card networks, also known as associations. Without the associations, credit or debit card payments wouldn’t be possible. These entities are responsible for determining what the processing fees are for each transaction and play a critical role in the processing of card payments. 


The acquiring bank sends the payment details to the credit card network at the beginning of the process. The network then passes that information to the issuing bank. Once it gets a response from the issuing bank, the association sends the response back to the acquiring bank.

6. Credit Card Issuer/Issuing Bank

The credit card issuer is the bank that gave the cardholder their card. It can be a freestanding credit card company or attached to the financial institution a person uses. For example, a person might have a credit card from the same institution where they have a checking or savings account.


Also known as an issuing bank, the credit card issuer has the final say during a transaction. The issuing bank reviews the transaction details and the cardholder’s account and decides whether to approve or decline the transaction. It might decline the purchase if the cardholder is near or above their credit limit or if anything looks suspicious. For example, if someone tries to use a card to pay for something but reported their card lost a few days prior, the issuing bank will decline the transaction.

How Does a Third-Party Payment Processeor Work?

The payment processor is the intermediary during the transaction. It has the role of contacting associations and banks on behalf of the merchants. Without a payment processor, most merchants wouldn’t be able to accept credit or debit cards. The processor accepts the card information from the cardholder, then sends that information to the associations and issuing banks.


For example, let’s say a customer uses a Visa card to pay for a purchase. The payment processor receives the card details from the merchant, including the number, expiration date, security code and cardholder name. It passes that information, along with the value of the transaction, to the credit card network. The card network then passes the details on to the issuing bank. The issuing bank then sends a reply to the association, which passes it on to the payment processor. Based on the response from the issuing bank, the payment is either accepted or declined.


A payment processor shouldn’t be confused with a payment gateway, although the two are related and usually work together. One way to understand the difference between a payment gateway vs. a payment processor is that the payment gateway is the device — such as a card reader — that collects the information from a cardholder. In contrast, the processor is the service that sends the information to the next destination.


How Does a Payment System Work?

So, what is credit card processing and how does it work? Let’s take a look at how the payment process works in person — though the following example can also apply to how online payments work. In this case, Customer A has gone into a brick-and-mortar store and is buying a new set of sheets and bath towels.

Step 1: The Customer Pays

After choosing the products they want to buy, the customer heads up to the register to purchase them. The sales associate rings up the items and tells the customer the total due. The customer taps their card at the reader or inserts the card’s chip into the device to pay. 

Step 2: The Merchant Requests Authorization

Once the customer or cardholder has presented their card, the information about the sale and the card’s details get sent to the payment processor. For the payment to go through, the merchant needs to get authorization from the card’s issuing bank.

Step 3: The Payment Processor Passes the Information Along

The payment processor receives the transaction and payment details from the merchant’s point of sale system. It now has the responsibility of making sure that the credit card network and the issuing bank receive the information.


First, it’ll send the transaction details to the credit card network. Next, the details will travel to the issuing bank. As part of the process, the payment processor will request authorization.

Step 4: The Issuing Bank Reviews the Details

Once the issuing bank receives the transaction details, it reviews them. It’ll look at the card number, expiration date and the purchase amount. The issuing bank will also look for security codes and address verification to reduce the risk of fraud. 


If the purchase amount won’t push a person over their credit limit and there are no other issues with the card, the issuing bank will authenticate the transaction. A hold for the purchase amount will be placed on the cardholder’s account.


The first four steps in the payment process all take place nearly instantaneously. The information travels to the issuing bank and back again in a matter of seconds.

Step 5: The Transaction Clears

The fifth step takes a bit longer. The transaction needs to settle or clear. When you pay for something with a credit or debit card, and it appears as a pending transaction on your account, it’s because the issuing bank needs a bit of time to transfer the funds to the acquiring bank. Depending on the merchant and the banks involved, it can take a day or two before the transaction is finalized.


Explanation of Payment Processing Fees

Payment processors charge fees for their services, and the amount and types of fees charged can vary from processor to processor. While some merchants might hesitate to accept cards as payment due to the cost of working with a payment processor, many realize that the upfront cost is worth it. You risk losing or turning away customers if you only accept cash.


Take a look at some of the fees associated with payment processing, so you have an understanding of why they’re there and what they do:


  • Interchange fee: The card network sets the interchange fee and updates it regularly. The fee is what the merchant pays to the issuing bank to settle the transaction. While the interchange fee is the most considerable fee a merchant needs to pay, how much it pays varies based on several factors. Whether the card is a debit or credit card also affects the interchange fee rate, as does how the card is presented.
  • Merchant discount rate: Note that the merchant discount rate or fee is an amount charged to a merchant by a payment processor, not a discount the merchant received. The discount fee is usually between 1 and 3%.
  • Assessment fee: The card network also charges an assessment fee, which is meant to help it cover the costs of maintaining its network. The fee is a percentage of total monthly sales with the credit card network. Usually, the card networks charge the payment processor, which passes on the fee to its merchants.
  • Payment processor fees: A payment processor can charge a range of other fees to merchants, depending on the services it provides — some charge an equipment fee to cover the cost of card readers and point-of-sale devices. Additional possible costs include statement fees, withdrawal fees and authorization fees. Some also charge gateway fees if a merchant uses a gateway.


While fees are unavoidable, how you pay and how much you pay can vary. A payment processor might offer you the option of choosing a flat fee or a tiered fee structure. Whichever you use, make sure you have an understanding of what you’ll have to pay every month.

Returns, Chargebacks and Disputes

While consumers are likely to be happy with the products they buy or services they purchase, there might be instances when they return a product or dispute a charge on their card. Returns and disputes can be challenging for merchants. You risk losing the profit from the sale, and you also might have to pay additional fees to the payment processor and card network. 


Let’s look at a dispute example.


A customer orders a product from your website. You package and ship it, but the customer says it never arrived. You used tracking on the package and can see that the freight company delivered the package on a particular day. You refuse to give the customer a refund since they seem to have received the item. 


The customer then opens a dispute with the card company, saying that they never got the product. The card company decides to side with the customer and issues a chargeback, refunding the transaction amount. You, as the merchant, lose the value of the transaction, and you might have to pay the card network a chargeback fee.


In some cases, a customer might return a product to your company, so you issue a full refund to them. However, you aren’t likely to get the original interchange and processing fees you paid back. You might also have to pay the payment processor a fee to process the refund.


While you can’t eliminate fees or chargebacks, you can work with a payment processor that offers a fee structure that suits your company’s needs.

Work With Zen Payments Today

Zen Payments specializes in working with companies in high-risk industries. If you’re ready to start accepting card payments, we can facilitate the process for you, no matter the industry. Get in touch and receive a quote in 24 hours.