Have you ever stopped to wonder what happens when you tap your credit card or press ‘pay’ online? As a business owner, have you ever been curious about what happens after a customer pays you in the same way? It’s not only interesting to know; it can also help you optimize your systems to get the most out of the process and even save money along the way.
Whether you receive payments from Visa or Mastercard, or another card network altogether, the process is relatively the same. However, the sheer number of credit card transactions every year is staggering. In fact, US credit card payments hit an estimated total of $3.625 trillion in 2024.
In this guide, we’ll dig deeper into what really happens when a customer pays you via credit card and what you can do to maximize returns.
TL;DR
- Credit card transactions follow a complex process from the moment a card is tapped to final settlement between financial institutions.
- The transaction lifecycle includes authorization, authentication, clearing, and settlement, each involving multiple parties like the cardholder, merchant, acquiring bank, card network, and issuing bank.
- Various transaction types exist, including purchases, pre-authorizations (e.g., for hotels), refunds, and chargebacks, each with unique flows.
- Every transaction incurs costs for merchants, including interchange fees, which can influence pricing and business strategy.
- Behind the scenes, robust technology infrastructure, including POS terminals, payment gateways, and security protocols, ensures speed and security.
The Anatomy of a Credit Card Transaction
One single credit card transaction includes several steps and entities that all work together to complete the process. The customer making the payment sees none of this, but without this behind the scenes work, the payment wouldn’t be successful. When you ask, ‘how do credit card transactions work,’ it will probably come as a surprise at how fast the process really is – all happening in milliseconds.
The Hidden Players in Transaction Processing
We’ve mentioned that when a customer makes a contactless payment, several entities work together to process the payment. Each has an equally crucial role in the entire flow, and it’s important to understand each step to explain why some transactions occasionally fail.
The Acquiring Bank's Critical Role
Let’s start with the acquiring bank. This is the merchant’s (business) financial institution and it plays a key role in the payment processing journey. It can also be the payment processor themselves. One task is to receive authorization requests from merchants and they take on the responsibility for the transactions at the start.
From a business standpoint, acquiring banks/payment processors decide whether or not to grant a merchant account to businesses. This is based on their individual risk factors. For instance, if you’re a high-risk business, you may find it harder to access traditional payment processing services.
For that reason, it’s important to find a payment processor that offers high risk merchant accounts, such as PayCompass. We don’t believe in making your journey any harder than it already is, and our accounts are designed to overcome the payment processing challenges you face on a regular basis.
Payment Processors as Transaction Facilitators
We mentioned payment processors, so what do they do? These are the technological foundations that allow a credit card transaction to go through. They offer a secure infrastructure that routes transaction data between each stage, converting information from the moment a customer taps their card.
The table below gives some key information about the payment processor type and their key services.
Payment Processor Type | Role in Transaction | Key Services |
Front-End Processors | Initial transaction capture | Terminal services, payment gateways, data encryption |
Back-End Processors | Settlement and funding | Batch processing, reconciliation, merchant funding |
Integrated Processors | End-to-end processing | Combined services, unified reporting, single point of contact |
Card Networks: More Than Just Logos
Next, we have card networks, such as Visa, Mastercard, Discover, and American Express. These are huge networks that play a key role in transactions worldwide.
These networks have their own processing standards and charge interchange fees for their work. These fees cannot be negotiated, yet card networks do offer a range of card types that cardholders can use. From a business perspective, card networks play a strong role in disputes.
The Millisecond Journey of Authorization
Credit card transactions take place within seconds, often instantly, but within that time there are many security checks taking place. At the point of payment, the system starts verifying the customer’s account status, whether the transaction is legitimate, and if there’s enough money on the card to cover the purchase.
All this is done through sophisticated algorithms that work to identify any issues in real-time. Once these checks are complete, the transaction is approved.
Tokenization: The Unsung Security Hero
One extremely important part of transaction security is tokenization. This protects sensitive information during transmission, disguising it as a token that cannot be read if somehow intercepted. Tokenization happens at the point of transaction, so it offers a secure pathway from the moment the payment is initiated.
All this is done through sophisticated algorithms that work to identify any issues in real-time. Once these checks are complete, the transaction is approved.
Velocity Checks and Fraud Detection Algorithms
There are many different types of credit card fraud around, and it’s important to cover all bases when it comes to fraud protection. As a card payment is processed, algorithms check for any suspicious activity, using things like transaction frequency, account patterns, location, and the category code of the merchant.
A credit card transaction example that could be flagged includes a customer who has used their card in one state and then uses it quickly in another. Additionally, if it is a high-risk business that’s being paid, the category alone could cause the payment to be delayed or even held.
All this is done through sophisticated algorithms that work to identify any issues in real-time. Once these checks are complete, the transaction is approved.
The Transaction Lifecycle: From Tap to Settlement
A credit card transaction goes through a fast yet accurate process from authentication to settlement.
Source: unsplash.com
What is a credit card transaction if not fast? The reason it’s gained that reputation is because of the speed and accuracy of these types of payments. It’s interesting to learn about the average lifecycle of a credit card transaction, which kickstarts the moment a customer taps their card.
However, different types of credit card transactions take varying amounts of time, e.g., if the card was present or not. This explains why some transactions appear immediately on a customer’s statement and some take a few days to appear.
On average, the lifecycle of a transaction takes between 24-72 hours to reach final settlement, yet weekends and holidays seasons can create delays.
Authorization vs. Settlement: The Critical Distinction
Many people confuse authorization and settlement, but these are two separate processes that work differently. Authorization comes before settlement, and it’s the point when the transaction is approved and a hold is placed on the customer’s funds. Settlement is when the money appears in the business’ bank account, once the entire payment process is complete.
The Authorization Hold Phenomenon
If you’ve ever seen the word “pending” on your statement after a payment, this is because it has been authorized but not yet settled. It’s a temporary hold on your funds that reduces your available credit but doesn’t actually transfer the money.
However, after a few hours or days, the transaction should appear as a settled amount. If the amount disappears, the transaction was not successful.
Batch Processing and Settlement Windows
Most businesses don’t process each individual credit card transaction; instead, these are batched and submitted all at once.
The table below gives some more information about batch processing and when funds are likely to be available.
Settlement Window | Typical Time (EST) | Transactions Included | When Funds Available |
Morning | 9:00 AM – 10:00 AM | Previous evening batches | Next business day |
Afternoon | 2:00 PM – 3:00 PM | Morning batches | Next business day |
Evening | 7:00 PM – 8:00 PM | Afternoon batches | 2 business days |
Weekend | Limited or none | Held until Monday | Tuesday or Wednesday |
The Post-Transaction Ecosystem
The story doesn’t end when a credit card transaction is completed. At this point, there are still several processes that take place, including reconciliation, reporting, and analysis. These processes are vital for generating important data and can be used for marketing, fraud prevention, and for making other important decisions.
Reconciliation Challenges for Merchants
After completion, businesses must reconcile their point of sale system records against the settled batches. This is a complex process that can, if done incorrectly, lead to errors and leakage of revenue. Common causes of issues at this point include connectivity, manual entry errors, and differences in timing. However, using an automated system can reduce errors and ensure overall accuracy.
Credit Card Transaction Example: A Real-World Walkthrough
Credit card transactions can also be made via mobile means, connected to physical cards.
Source: unsplash.com
Let’s look at a credit card transaction example from start to finish to highlight the process in more detail. We’ll use a coffee purchase to show how one tap of a card creates a cascade of complex processes.
The Coffee Shop Transaction Dissected
Picture the scene: you go into a coffee shop and spend $5 on your favorite latte. You tap your card on the payment terminal and less than one minute later, you walk out of the store with your coffee in your hand. What happens behind the scenes?
Your coffee purchase generates around 15-20 cents in processing fees that are distributed amongst all necessary parties within the ecosystem. Your transaction data also goes through between four and six different computer systems before it is approved and you can walk out with your coffee. The store you purchased your coffee from typically receives your money in their merchant around around 24 to 48 hours after you received your beverage.
Let’s look at this credit card transaction step-by-step.
Step 1: Card Presentation and Initial Data Capture
You tap your card. At this point, the EMV chip creates a unique transaction code, while the payment terminal collects the merchant ID, payment amount, and the accurate timestamp. Within milliseconds, this information is combined and sent as an authorization message. This is the first step in the approval process.
Step 2: Authorization Request Routing
Transaction authorization goes from the payment terminal to the payment processor. It then goes to the card network, and finally arrives in the issuing bank. All the while, sophisticated algorithms are conducting background checks for any suspicious patterns and for sufficient funds. Once all of this is complete, an approval code goes back through the same pathway, completing the purchase.
Step 3: Batch Settlement and Funding
Once the working day is over, the coffee shop batches all that day’s transactions together to send for settlement. The payment processor aggregates this batch of transactions, before the acquiring bank credits the business’s account, minus the fees to be paid to each individual entity. The card network facilitates movement of the money from issuing banks to finalize the cycle.
Behind-the-Scenes Fee Distribution
We just mentioned credit card transaction fees, and these must be paid to various entities within the payment ecosystem. Whether the transaction is worth $5 for a coffee or thousands for a fancy gadget, the fee infrastructure remains the same. However, some merchants offer discounts for cash so they can reduce credit card processing fees over time.
Interchange Fees: The Largest Slice
The largest slice of the fee pie belongs to interchange fees, and these are non-negotiable as they are set by card networks. Interchange fees are typically 1.4% to 2.5% for Visa, and 2.5% to 2.6% for Mastercard. As you can tell, these fees are one of the major revenue streams for banks that issue credit cards to customers.
Assessment Fees: The Card Network's Cut
You might wonder why the card network gets their revenue from, and in this case it’s assessment fees. These range between 0.13% to 0.15% of each transaction, generating a huge amount of revenue for card networks every year.
Processor Markup: The Negotiable Component
Next, we have the slice of the pie that goes to payment processors and acquiring banks. Rates generally start at 0.25% on top of both interchange and assessment fees. However, it’s possible to reduce these by negotiating directly with your payment processor. The ability to do this, and how much by, depends on several factors, including industry risk, processing history, and merchant volume.
Types of Credit Card Transactions
Now let’s talk about the different types of credit card transactions.
Whether the transaction is a standard purchase or a recurring subscription payment, it goes through a payment processing journey. However, in some cases, payments can appear differently on a statement or process a little slower.
Standard vs. Specialized Transaction Types
Specific transactions trigger different authorization processes, fee structures, and settlement timelines, even if the overall journey is the same. Within this, credit card transaction types are identified by codes that decide how they are processed.
In most cases, specialized transactions require extra data before they can be authorized. Of course, it also makes sense that some higher-risk transaction types attract an increased level of scrutiny in fraud detection systems.
Card-Present vs. Card-Not-Present Dynamics
Card not present credit card transactions are deemed riskier, therefore attracting higher processing fees.
Source: unsplash.com
Generally, card present transactions are considered less high-risk because the person is in front of you with their card. Because of that, processing fees are lower than in card not present transactions. The risk profile of card not present payments is higher, therefore attracting higher processing costs and stricter scrutiny.
To illustrate, card present transactions have interchange fees between 1.70% – 2.05%, while card not present transactions charge between 2.25% to 2.65%.
The Future Evolution of Credit Card Transactions
Everything in life and business evolves, ebbs, and flows, and credit card transactions are no different. It’s likely that the payment processes we see today will look very different in a few years’ time, including mobile credit card processing.
Let’s explore some potential developments.
The Rise of Embedded Finance
It’s likely that transactions will become increasingly embedded in our everyday experiences, increasing personalization, and focusing even more strongly on security. The overall aim is to balance protection and convenience.
Invisible Payment Integration
Payment transactions are becoming more invisible as the years go by. In this, payments are triggered by a particular action rather than going through a checkout and a series of payment steps.
This is a frictionless approach to payments which could, in time, completely replace the checkout process with biometric verification and pre-authorized payment credentials.
Regulatory Influences on Transaction Processing
Of course, regulations will no doubt influence credit card transactions into the future, especially where open banking and data privacy are concerned. This creates challenges, for sure, but it also creates a range of opportunities for both customers and businesses alike.
The aim of these regulatory changes is to boost competition, increase security, and protect customer rights. Of course, additional compliance requirements means more complexity, but this can be a driver for innovation. The biggest challenge comes in the various regulatory differences across regions, with businesses having to follow regulations in the areas they operate in.
Strong Customer Authentication Requirements
Many regulators are increasingly focusing on customer authorisation through multi-factor means. In most cases, this includes the card details, a PIN number, and a biometric element. The extra security steps can add new friction points, but they certainly increase security.
The key is for payment processors to come up with new innovations that can reduce noticeable friction for customers and in creating new behind the scene risks assessment methods.
Final Thoughts: Simplifying Credit Card Transactions with PayCompass
We’ve reached the end of our guide to credit card transactions – did you learn anything new and/or surprising? It’s likely, because the entire process is much longer and includes more entities than most people think. Yet, all of this is done in milliseconds, which is probably why customers in particular don’t realize the amount of work that goes on behind the scenes.
For businesses, understanding the types of credit card transactions and the process in general can unlock savings. While interchange fees can’t be negotiated, payment processor fees can, and this is an area to focus on.
Of course, if you fall into the high-risk industry, you’re probably more than aware of the payment processing challenges that may come your way. Perhaps they have already. That’s where PayCompass comes in. We have designed our merchant accounts with your needs in mind.
We don’t believe you should have to struggle with credit card payment processing just because your business is deemed high-risk. In fact, we believe you should have the same rights to services as everyone else. That’s why our accounts address the challenges you face, with chargeback prevention, fraud protection, and real-time monitoring to name just a few specific features.
So, if you’re ready to streamline your payment processes and look toward business growth rather than stress, reach out to us today!
