How Does Payment Processing Work?

The essence of payment processing is simple: a customer sends a company an amount of money, and the company confirms that the transaction has been processed. Payment processors do this by facilitating transactions between customers' bank accounts or credit cards and a merchant's checking account. For consumers who want to use a credit card for online purchases, payment processors play an important role in making e-commerce possible.

How Payment Processors Work?

There are four major players involved in a payment transaction between a customer and a merchant: The customer uses a payment card, such as a credit or debit card, to make the purchase from the merchant. The retailer's checkout system sends the transaction information to the acquiring bank or payment processor. The bank must ensure that the customer has enough available money on the card to make the purchase, and if it's a debit card, that there are funds in their checking account to cover it. It then authorizes the transaction with either the credit card company or the debit network (e.g., Visa or MasterCard).

The credit card company (for debit cards) or the issuing bank (for credit cards) pays the merchant for the transaction. The customer receives whatever goods or services they paid for with their purchase, and is happy that they got what they wanted when they expected it.

A payment processor's job is to facilitate this entire process-from the moment the customer decides to make a purchase to when they receive their merchandise.

How Payment Processing Works?

The three major types of payment processing are credit cards, debit cards, and electronic checks. Each has its own set of technologies that determine security levels, transaction speed, liability for loss or theft of funds during the current transaction cycle, and so on.

Credit Cards

Credit cards are used for goods and services that can be delivered later, such as airline tickets, hotel stays, and online purchases. They're also the most common form of payment in the US: About 80 percent of Americans use them regularly and 66 percent carry a balance from month to month (source: "How We Use Credit Cards in America," Bankrate.com, October 13, 2011).

Credit cards are issued by banks or other financial institutions and require customers to pay back the full balance of purchases that they didn't pay off during the billing period. Customers incur finance charges because they aren't paying off their entire purchase during the billing period. The issuer may report a customer's credit history to the consumer reporting agencies, and this will affect their future ability to obtain new lines of credit or loans.

Credit cards provide consumers with protection against unauthorized use of a card in most cases, as long as they report it promptly. Merchants are protected from problems such as chargebacks from customers-when customers dispute a charge on their card, the credit card issuer will handle it for them. The consumer's liability is often limited to $50 and the merchant can't hold customers liable for more than $50 in fees or penalties.

Here's how it works?

When the customer makes a purchase using a credit card, the store requests authorization from the credit card issuer. This is done through a direct connection from the store's sales system to the bank that manages the customer account. If everything checks out, then the merchant receives an approval code, allowing them to ship or provide services for their customers. This process is known as authorization and settlement.

Settlement happens when a payment processor receives the funds from a merchant for all transactions that were approved during the authorization process. For example, you might authorize a restaurant to charge your credit card for dinner on Saturday night, but not pay them until Monday when you get paid.

Author's Note

The three major types of payment processing