Everything You Need to Know About Payment Processors (2023)

What Is Payment Processing?

A credit card transaction may appear to be as simple as a swipe, dip, or tap, but behind the scenes it involves many phases and participants. Payment processing is the process by which companies complete credit card and debit card transactions.

Payment processing services speed up card transactions, while payment gateways securely transmit data so money from a customer's issuing bank can be transferred to a merchant's account in milliseconds.

The result is a consumer who completes an order without having to use cash or a cheque—as well as a company that makes revenue.

Point of Purchase

The point of purchase is the time when a client begins a commercial transaction with a merchant and offers a payment choice, such as debit or credit card, cash, check, or money order. Customers are also using digital payment methods to make in-store and internet purchases.

Payment Gateway

A payment gateway is software that links a customer's bank information sent through the payment processor to the merchant's account. The payment gateway informs the processor about whether or not the transaction has been accepted, but it is the processor who steers the transaction by collecting card data from the client's issuing bank (credit card/debit card) and transferring it to the merchant account.

Payment Processor

Payment processors act as couriers, relaying information from credit card users at issuing banks to merchant accounts where accepted payments are subsequently recorded. The payment processor validates the security of the cards and helps to move money from the issuing bank to the merchant account by automating the verification process.

Issuing Bank

The issuing bank is a financial firm connected to the customer's credit card account.

Merchant Account

When a credit card transaction is authorized and completed, the payment processing company helps move money from the issuing bank to the merchant account. This bank account allows a firm to take cards of all types.

What Is a Point of Sale?

The heart of a merchant's payment infrastructure is a point-of-sale system (POS). POS systems include hardware and software that allow businesses to take payments, keep records, and perform other business operations such as scheduling appointments or paying payroll.

Customers have the option of paying with various payment options, such as a credit card like American Express, a digital wallet, a debit card, or an online payment. A merchant's POS finalizes sales transactions by including sales tax, accounting for discounts and promotions, and issuing receipts.

How Do Payment Gateways Work?

However, while payment processors and payment gateways are not synonymous, they are both essential to executing a cashless transaction using a credit or debit card.

The payment gateway establishes an encrypted connection between the merchant and the customer to secure the transmission of credit card data. The payment processor transfers money from one account to another.

The payment gateway checks a card's validity while preventing personal information such as names, addresses, and credit or debit card numbers from leaking during the transaction.

When a customer makes a purchase using a credit or debit card, data from the card is sent to the payment gateway, which communicates with the issuing bank that will accept the charge. Once the payment gateway receives the cardholder's bank identification number, which it has previously received from the card-issuing bank.

The transaction is then verified by the card-issuing bank, and a code is transmitted to the payment processor, which transmits that code to the payment gateway. The merchant and consumer are then sent an authorization acknowledgment on the card reader. It takes only a few seconds for everything to happen.

Payment gateways are sometimes combined with virtual credit card terminals or offered as an in-house service from a payment processor, allowing merchants to handle their customers' transactions through one organization. Many companies find the additional layer of protection provided by a payment gateway to be appealing.

How Do Payment Processors Work?

A payment processor is a business that handles credit and debit card transactions for merchants. Payment processors seek approval for a transaction, contact the cardholder's issuing bank, and transfer money into a merchant account.

Merchants may choose to use a subscription-based payment processing service with a monthly fee, which comes in several different forms. A merchant can be charged each time a customer uses their credit or debit card.

These expenses might include a credit card company's interchange rate, also known as a swipe fee. Payment processors typically charge either an interchange-plus or a flat-rate transaction fee. The interchange-plus model is where the processor charges a fixed amount for the exchange and an additional charge on top of that.

For example, a processor may charge 1.8% of the purchase as the interchange fee and then another percentage or charge, such as 0.3 percent or 7 cents, on top of that. Flat-rate rates are usually above the interchange rate. The expense of the interchange rate would be covered by a 2.9 percent fee charged by the processor based on the transaction, with any additional amount being determined by negotiation between buyer and seller or other agreement in place. (Here's how to avoid credit card processing fees.)

Many processors offer a payment gateway or merchant account that covers these essential services at a fixed monthly cost. For example, merchants may be charged extra if they receive a chargeback or insufficient funds.

Payment processors are required to follow the Payment Card Industry Data Security Standard (PCI-DSS) by the PCI Security Standards Organization (PCI-DSS).

Merchants and service providers must securely handle, transmit, and store cardholder information during the transaction process. It's critical that you pick a credit card processor that is PCI compliant. The protection of your client's personal information is critical to maintaining a successful and lucrative company.

If a firm conducts in-person transactions, it should look at EMV-chip card POS systems. For in-person sales, EMV cards add another layer of protection against fraud. Embedded cards are now the standard for fraud prevention, and most payment processors can supply EMV-compatible terminals.

Some payment processors bundle services, such as a payment gateway and merchant account, so you can complete transactions using a single credit card processing firm.

What Are the Differences Between a Payment Processor and a Credit Card Processor?

The payment processing system is a system that allows customers to make payments using credit cards and debit cards. Payment processors are businesses that process credit card transactions and are frequently known as credit card processors.

What Is a Merchant Account?

A merchant account is a storage location for pending cardholder transactions. After a credit or debit card payment has been authorized and settled, it is passed from the card issuer to a merchant account. Then, those funds are paid into a company's bank account.

A merchant account and a business bank account function differently. A business account handles expenses related to operations, such as paying for rent. A merchant account is only for credit card processing.

In the payment processing chain, the merchant account is the landing pad for payments. After cardholder transactions are successfully processed and approved, it transfers to a merchant account. Usually, within 24 hours to three days, payments are moved from a merchant account to a business's financial institution via an ACH transaction.

Payment processors create merchant accounts for businesses. Merchant accounts can be added as an extra feature to payment processors, or they may be included with a POS system.

Small firms might want to start processing payments by joining up with a payments aggregator (payment facilitators) such as PayPal, Stripe, or Block so they can use the master merchant account as a sub-merchant.