How Does a Payment Processor Work?

March 12, 2023 | Merchants | Dustin

Fewer and fewer Americans are using cash to make purchases. Instead, credit cards and digital payment methods are making up more transactions than ever before.

Many companies today feel that they would benefit by partnering with a payment processor. This way, they could digitally accept mobile payments, debit cards, and credit cards.

Payment processors give businesses the tools to accept a variety of payment methods while also making those transactions both easier and safer. Of course, payment processing doesn’t come without its costs and complexities.

So how does payment processing work? Continue reading and we’ll walk you through everything you need to know.

Credit Card Transaction Players

Before we dive into payment processors, let’s first talk about the participants involved in a credit card transaction. This will help give us a more complete understanding of how it all works.


First, we have the merchant. This is the vendor or store that is selling goods or services to the cardholder.

The merchant is the one who accepts credit card payments. They also send the card info to- and request payment authorization from- the cardholder’s issuing bank.


Credit Card CompaniesThe Cardholder is the one who is paying for the goods or services. There are two types of cardholders out there. First, there is the “transactor”. This person repays the credit card balance in full.

There’s also the “revolver. This type of cardholder repays only a piece of the balance while the rest of it accrues interest.

Merchant’s Bank/Acquiring Bank

The merchant’s bank/acquiring bank is responsible for receiving the payment authorization requests from the merchant. The bank then sends them to the issuing bank. It then delivers the response from the issuing bank to the merchant.

Service Provider/Payment Processor

The service provider/payment processor is a third-party entity that is sometimes part of the merchant’s bank.

The processor provides a device or service that enables the merchant to accept credit card payments as well as send those payment details to the credit card network.

The payment authorization is then forwarded to the acquiring bank.

Association Member/Credit Card Network

The association member/credit card network operates the networks that are in charge of interchange fees and process credit card payments worldwide. Examples of credit card networks are American Express, MasterCard, Visa, and Discover.

During the transaction process, the acquiring processor will send the details of the credit card payment to the credit card network. The credit card network then sends the payment authorization request to the issuing bank. It will then forward the response from the issuing bank to the acquiring processor.

Credit Card Issuer/Issuing Bank

The credit card issuer/issuing bank is the financial institution that issued the credit card to the cardholder. The issuing bank receives the payment authorization request from the credit card network and then either declines or approves the transaction.

What Is a Payment Processor?

Choosing a bankBy acting as the intermediary between financial institutions and businesses, a payment processor allows both brick-and-mortar companies as well as e-commerce ones to accept different types of payment methods.

A payment processor is able to check on the validity of a payment by contacting the customer’s issuing bank in real-time.

And even though some businesses might be turned off by the idea of having to pay to use the processor, the fact that they can more easily accept different payment methods and serve more customers means that they could potentially raise their revenue stream.

A company can integrate its payment processing solutions with POS (point-of-sale) systems or use a payment processor on its own.

To put it another way, a company can choose a system that utilizes both the payment processing service and POS system, or they can opt to use a POS provider and then a separate company for payment processing.

Sometimes referred to as payment services providers, this all-in-one system option gives companies the opportunity to keep all of their payment data in one place. This can decrease confusion, save time, and even lower costs.

It’s also important to point out that payment processors are different from payment gateways. Payment gateways are applications that transfer the customer’s payment to the merchant’s bank.

With that said, payment processors and payment gateways generally go hand-in-hand.

How the Credit Card Transaction Process Works

Credit card transactions are processed through different kinds of platforms, including e-commerce stores, brick-and-mortar shops, mobile or phone devices, and wireless terminals.

The entire process, from the moment you insert your card into the card reader to when your receipt comes out, takes place within a matter of seconds.

Using a brick-and-mortar shop as an example, let’s take a look at how the whole process comes together.


A customer goes into a store and decides to buy an item from the merchant. At check out, depending on how it’s set up, the customer may insert or swipe their card, scan their mobile device, or manually put the payment information into the online payment gateway or POS.

During this stage of the transaction process, the merchant is going to have to get approval from the cardholder’s issuing bank.

The payment information for that customer is then sent to the payment processor. The payment processor will evaluate the validity of the transaction. It will do this by communicating both with the acquiring bank and the issuing one.

The credit card details are then sent to the credit card network. The network will clear the payment and request payment authorization from the issuing bank.

That authorization request will include the credit card number, the billing address (for Address Verification System validation), credit card expiration date, the payment amount, and the card security code – such as the CVV.


Credit Card TransactionAt this part of the process, the issuing bank will verify the legitimacy of the shopper’s credit card by using card security codes such as CVV, CID, CVV2, and CID.

They will also use fraud protection tools such as the AVS (Address Verification Service).

Basically, the payment authorization request is delivered to the issuing bank from the credit card network. The issuing bank will check the amount of available funds, validate the credit card number, validate the CVV number, and match the billing address to the one that they have on file.

The issuing bank will decline or approve that transaction and then send it back through the same channels to the merchant with the appropriate response.

The issuing bank will then put a hold on the cardholder’s account in the amount of the purchase once the merchant gets the authorization. That merchant’s POS system will gather all of the approved authorizations that will be processed in a batch at the end of that business day.

The customer will receive a receipt from the merchant in order to complete the sale.

Clearing and Settlement

In this final stage, the transaction is posted to both the merchant’s statement and the cardholder’s monthly credit card billing statement. This all occurs at the same time as the settlement stage.

After each business day ends, the merchant will forward the approved authorizations to the payment processor in a batch. The acquiring processor will then route that batched information to the credit card network so that it can be settled.

The credit card network will then send each of the approved transactions to the corresponding issuing bank.

The bank will typically transfer the funds within 24 to 48 hours. This is minus the interchange fee which the issuing bank shares with the credit card network.

The credit card network then pays the acquiring processor and acquiring bank the appropriate percentages from the funds that are left. The merchant’s account will be credited by the acquiring bank for cardholder purchases minus a merchant discount rate.

The cardholder’s issuing bank then posts the information from the transaction to the account of the cardholder. The cardholder then receives their statement and pays the bill.

Costs and Fees for Credit Card Processing

Many merchants accept credit card payments to make shopping more convenient for their customers. However, you have probably noticed that some merchants out there only accept cash or have minimum purchase requirements when customers want to pay with a credit card.

This is because merchants need to pay fees when they accept a credit card payment.

Credit card processing rates will vary depending on the type of platform that the payment is made on (such as through e-commerce or at a retail shop).

Let’s look at the main types of fees that a merchant can expect to pay for payment processing.

Flat Fees

The flat fee makes up the monthly rate that the merchant pays to have the payment processor. It’s the same price every month.

Transaction Fees

These costs accrue on a per-transaction basis. Usually, they’re made up of three parts: interchange rate, the assessment fee, and the merchant discount rate.

These three parts help make sure that the credit card network, payment processor, receiving bank, and issuing bank all get a piece of the transaction fees.

These fees tend to be between 2% and 3% of the total purchase price after the sales tax has been included. Online merchants can expect to pay at the higher end of the scale.

Interchange Rate

The interchange rate is what the acquiring processor and acquiring bank pay to the issuing bank. It’s set by each credit card network and is market-based.

For example, MasterCard and Visa update their rates twice a year.

Most interchange rates have two components: a fixed transaction fee to the credit card network and a percentage that goes to the issuing bank.

These rates vary and are determined by several factors including:

  • Processing method
  • Card type
  • If the physical card is used during the transaction
  • Credit card company
  • Merchant’s business type


A credit card network will charge an assessment fee when a transaction is made with their branded credit cards.

The fee is typically based on a percent of the total amount of transactions for the month. This tends to be a flat, fixed fee and they’re usually charged per transaction.

Merchant Discount Rate

Payment processors and acquiring banks will include a merchant discount rate along with their other transaction fees. This is both for profit reasons and to cover the costs associated with running credit card transactions.

This tends to be around 20% of the total costs for card-processing.


Customers are able to dispute a charge within 60 days of the statement date. When the issuing bank gets the customer’s complaint, it will slap the merchant with a charge of anywhere between $10 and $50 as a penalty as well as for a retrieval request.

The merchant can also incur even more fees if they don’t respond to the issuing bank’s retrieval request in time. The merchant can appeal this but the appeal process tends to take a long time and the outcome usually ends up in the customer’s favor.

The Importance of Knowing the Answer to “How Does Payment Processing Work?”

After reviewing all of the above information, you hopefully understand the answer to the question, “how does payment processing work?”.

Payment processing may seem like a complex process but it’s able to simplify the payment process and allow merchants to focus more time and attention on what they do best – selling their goods and services.

Are you a merchant in a high-risk industry? If so, it’s best that you choose a payment processor that understands your business and can help you thrive.

Check out our homepage to see how you can get a free QuikQuote!

Comparing merchant services is the financial part of running a successful business. Find out here what to look for when choosing a credit card processor.


March 12, 2023 | Merchants | Dustin