It’s essential to understand how credit card payments work if you want to manage your money. While credit cards provide you with flexibility, their payment processes can be complex. This guide outlines the key stages from making a purchase to paying off your balance, helping you minimise fees and interest.
Table of Contents
Understanding Credit Card Payments
Key Players
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Cardholder: The individual issued a credit card is the cardholder responsible for repaying borrowed credit.
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Merchant: The business that accepts credit card payments for goods or services, benefiting from improved payment methods and increased sales.
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Payment processor: The intermediary that facilitates transactions between the cardholder and the merchant, ensuring secure processing, is the payment processor.
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Card Issuer: The financial institution that provides the credit card, manages the account and collects payments from the cardholder.
Basic Payment process
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Step-1 Initiation: The cardholder initiates the process by giving the retailer their credit card details.
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Step-2 Request for Authorisation: The merchant notifies their payment processor with the details.
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Step-3 Check for Approval: The payment processor contacts the card issuer to obtain approval.
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Step-4 Response: In response, the card issuer either approves or declines the transaction.
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Step-5 Finalisation: The merchant completes the transaction if it is accepted.
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Step-6 Settlement: To transfer funds, the merchant forwards authorised transactions to the payment processor.
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Step-7 Billing: The card issuer charges the cardholder the purchase amount on their subsequent statement.
How do Credit Card Payments Work?
Credit card payments involve multiple parties and may seem overwhelming at times, but they ensure quick, secure transactions. This complexity streamlines financial exchanges, allowing consumers and businesses to quickly authorise payments, process them securely, and transfer funds seamlessly.
Stage 1 – Authorisation
This is the initial step in a credit card transaction. It verifies whether the card number is valid and if there are sufficient funds or credit available.
Authorisation request process:
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Merchant to Processor: When a consumer makes a payment, the merchant’s system notifies a payment processor of the transaction amount and card information. The processor handles the request and serves as an intermediary.
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Processor to Card Network: The payment processor sends the request to a card network, such as Visa or MasterCard, which then passes it to the bank that issued the card.
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Card Network to Issuing Bank: The credit card issuer, or issuing bank, sends the request for transaction validation to the card network. It verifies the card’s validity and determines whether enough credits or money are available.
Response
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Response from Issuing Bank: The payment processor receives an authorisation response from the issuing bank via the card network. If the transaction is approved, this response contains an authorisation code; if not, it includes a decline message.
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Processor to Merchant: On receiving the response, the payment processor notifies the merchant of the transaction’s approval or rejection
Confirmation
Authorisation confirms the card’s validity and availability of funds but does not finalise the transaction. Fraudulent transactions can still occur at this stage, necessitating additional protection measures.
Stage 2 – Authentication
Authentication focuses on verifying the cardholder’s identity to confirm that the individual conducting the transaction is the rightful owner of the card, and the merchant must confirm this even while the issuing bank verifies that the account is valid and has enough money or credit.
Authentication Methods:
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Address Verification Service (AVS): Ensures that the billing address entered corresponds with the address the issuing bank has on record to verify the cardholder’s identity.
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CVV Validation: This helps prevent unwanted use by confirming the card’s physical existence.
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Geolocation: Geolocation adds a layer of security by tracking the transaction location and comparing it with the cardholder’s normal whereabouts.
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Fraud detection tools: These devices use algorithms to look at transaction patterns and spot unusual or suspicious activities to prevent fraud.
Stage 3 – Batching
Merchants like you examine and aggregate several transactions before submission as part of batching. Transactions are combined into a single report, which is subsequently forwarded to the payment processor or acquiring bank for additional processing.
All transactions are pending until you complete and submit the batching report. This ensures that transactions are handled in large quantities instead of one at a time, which can be more productive.
The frequency of batching may vary depending on the business strategy. While some companies may batch transactions monthly or based on operational needs, others may submit transactions daily to sustain cash flow.
Additionally, batching lowers administrative costs and transaction fees. You can save money on processing fees and simplify accounting duties by simultaneously processing a batch of transactions.
Submission methods
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Manual Submission: Requires gathering and transmitting transaction data by hand, which can be time-consuming and error-prone.
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Automated Submission: This technique automates the batching process, lowering the need for manual labour, reducing the chance of error, and increasing productivity.
Stage 4 – Clearing
To conclude the payment cycle, several important entities process batches of submitted transactions throughout the clearing stage.
Transaction path:
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Payment Processor to Acquiring Bank: The payment processor receives the batch from the acquiring bank and manages the transaction information.
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Payment Processor to Card Network: The payment processor sends the batch to the card network, which handles transaction routing and includes Visa and MasterCard.
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Card Network to issuing Bank: The issuing bank houses the cardholder’s account and receives the batch the card network has directed.
Processing by Issuing Bank: To ensure the money is available and distributed correctly, the issuing bank takes the authorised transaction amount out of the cardholder’s account. This step confirms the payment’s validity, and the account balance is updated appropriately.
Interchange Fees: Interchange fees are applied during this stage to compensate for the expense of handling transactions. In addition to covering network processing expenses, these fees reimburse the issuing bank for completing the transaction.
Stage 5 – Settlement
Settlement is the final stage in which the company gets paid for the transactions it has handled. It involves the authorised funds being transferred from the originating bank, which has reviewed and approved the transaction, to the merchant’s bank, also referred to as the acquiring bank.
The acquiring bank subsequently deposits the money into the merchant’s account. The funds become usable when this operation formally credits the merchant’s account with the payment amount.
A prompt and effective settlement procedure is crucial for businesses to get paid on time. Settlement delays can impact cash flow, regular operations, and financial stability. Instant settlements support ongoing business operations and a sound financial position.
Stage 6 – Billing
After every billing cycle, the card issuer prepares a billing statement for the cardholder. This statement includes an in-depth breakdown of all transactions, charges, interest, fees, and the total amount due.
The billing statement stipulates a deadline by which the cardholder needs to pay the minimum amount. This date is essential to avoid late fees and other effects on the cardholder’s credit score.
The cardholder can pay the minimum amount owed, the entire sum, or any amount in between. Usually, payments can be made by phone, mail, or Internet banking.
Types of Credit Card Payments
1. Online Payments
Customers enter their information on a secure checkout page while making an online payment. After being encrypted, this data is transferred to a payment gateway, which authorises the transaction by corresponding with the issuing bank, card network, and payment processor.
Customers prefer this method for its security and efficiency, which ensure a seamless online shopping experience.
2. In-Store Payments
There are multiple ways to pay with credit cards in-store. Consumers can use contactless payments by tapping their cards or mobile devices on POS terminals, inserting chip cards (EMV cards) for extra security, or swiping magnetic stripe cards. Each method improves customer satisfaction by providing simple, safe payment alternatives that fit various preferences.
3. Contactless Payments
Using NFC technology, contactless payments enable customers to make purchases simply by tapping their card or smartphone on a terminal. Many contactless transactions also use tokenisation and encryption to protect sensitive data, which offers ease and security in crowded retail settings.
This technique improves security while expediting the payment process by avoiding direct contact and reducing the chance of card skimming.
4. Mobile Payments
With apps like Apple Pay and Google Pay, customers can use their mobile phones to make payments. These apps use tokenisation and biometric authentication, like fingerprint or face recognition, to protect data and securely retain card information.
This approach satisfies modern demands for improved security and usability by providing a quick, practical, and safe means of handling transactions.
Security Measures in Credit Card Payments
1. Encryption
One crucial security technique that keeps credit card information safe is encryption, which transforms it into a coded format that can only be read by those with permission. As a result, someone who needs the decryption key cannot use the collected data.
To protect this data during transmission and guarantee that cardholder information is kept private, secure methods like SSL (Secure Sockets Layer) and TLS (Transport Layer Security) are frequently employed.
2. Tokenisation
Payment security is increased through tokenisation, which substitutes random, meaningless tokens for sensitive card information. A token is utilised to facilitate processing in place of the actual card information when a transaction occurs.
Because a token cannot be used to access the actual card data even if it is accessed, it lowers the risk of fraud and assists you in adhering to security regulations.
3. 3D Secure
Cardholders must authenticate themselves through a one-time code or a password delivered to their mobile device. This added security feature verifies the cardholder’s identity throughout the transaction, offering an extra layer of protection and helping to lower chargebacks and fraud.
4. PCI DSS
PCI-DSS (Payment Card Industry — Data Security Standard) is a set of security guidelines intended to guarantee that any business that accepts, processes, stores, or transmits credit card data does so in a safe manner. Companies who breach these standards risk paying significant fines and penalties.
By following these guidelines, you can ensure the security of your clients’ working environments and lower the risk of data breaches.
5. Secure payment gateways
Secure payment gateways protect transaction data during online and in-store payments. They encrypt sensitive information and communicate with the merchant and the payment processor, relaying important transaction data between the seller and the credit card companies.
Secure payment gateways help you transmit customer data safely, reducing the chances of interception and fraud. This necessary layer of security is essential for maintaining customer trust and ensuring a safe payment experience.
Frequently Asked Questions (FAQs)
1. What is the lifecycle of a card transaction?
A card transaction’s life cycle starts when the cardholder makes a purchase. Then it goes through authorisation, authentication, processing, clearing, and settlement before concluding with a fund transfer to the merchant.
2. What fees are associated with credit card payments?
Interchange, assessment, processing, gateway, and chargeback costs are among the fees associated with credit card payments usually incurred by the merchant to complete transactions.
3. What is the difference between chip cards and magnetic stripe cards?
Magnetic stripe cards contain static data, which makes them more susceptible to fraud and unauthorised access. On the other hand, chip cards use EMV technology to increase security by creating unique transaction codes.
4. How are refunds processed in the online card payment lifecycle?
The merchant initiates a refund request using their payment gateway to process refunds in the online card payment lifecycle. After receiving this request, the acquiring bank credits the cardholder’s account, which usually takes 5 to 14 business days to reflect.
5. What happens if my credit card payment is declined?
Insufficient money, expired cards, or inaccurate information are some of the reasons your credit card payment may be declined. Get clarity and possible help by getting in touch with your card issuer.
6. How do chargebacks affect the lifecycle of an online card payment?
Chargebacks reverse transactions, which can cause financial losses for retailers and interfere with cash flow, impacting the online card payment lifecycle. When a cardholder disputes a charge, the issuer is prompted to look into it and may even provide the customer with a refund.
