Credit cards don't process themselves. This is where merchant accounts come in. A merchant account is essentially the middleman that lets businesses accept credit and debit cards in person and online. But why are they a necessary part of accepting debit cards and credit cards, and does your business really need one in order to process electronic payments?
Here is a simple explanation of how a merchant account works, what to look for in a merchant account and how small businesses can get one. For a more in-depth look at merchant accounts, check out our Credit Card Processing Buyer's Guide, which will also help you figure out whether your business needs a merchant account and how to find the right one for your business.
What is a merchant account?
A merchant account serves as an intermediary between customers' bank accounts and your business's bank account as electronic payments, including credit card transactions, are processed. During a sale, the merchant account works behind the scenes to withdraw funds from the customer's bank and deposit them directly into the business's checking account. The process works the opposite way during a refund.
Once a payment processor has set up a merchant account for your business, you can begin conducting credit card and debit card transactions with your customers. To do so, you will usually also need some hardware, which might be available for purchase through your credit card processing partner. In some cases, the payment processor might even give you a free credit card reader to help you get started.
How payment processing works
When a credit card transaction is processed, information must be sent to a payment gateway to see if the cardholder has sufficient funds. For traditional transactions, this is generally part of the point-of-sale (POS) machine, which reads the cardholder's data and checks with the credit card company to ensure the transaction can go through. This is known as a "swiped" or "card-present" type of merchant account, which can include retail, restaurant or lodging merchants.
Card-present transactions are generally considered the least susceptible to fraud. This means that the rates associated with these transactions are often the lowest credit card processors offer. However, card-present transactions are not the only way to accept credit card payments from a customer.
A "keyed-in" or "card-not-present" transaction is done online through a payment gateway, which connects to the credit card company. Any business that wants to accept credit cards over the phone or via online portal requires a payment gateway. You could also employ a payment gateway if your customers frequently place pickup orders ahead of time.
The credit card processor you partner with can set up a payment gateway for you at the same time your merchant account is established. However, payment gateways generally cost an additional monthly fee, and card-not-present transactions usually have higher rates than card-present transactions.
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Payment processing and merchant accounts for e-commerce businesses
As businesses have gone increasingly digital, the payment processing industry has extended its reach to e-commerce businesses. E-commerce companies are in even more serious need of payment processing services than brick-and-mortar businesses, because it isn't feasible to accept cash or checks online. However, the types of merchant accounts available for e-commerce businesses are different than those for brick-and-mortar stores. These are some of those types:
Direct: A direct merchant account is applied for directly at a merchant bank.
Local: A local merchant account is an account in one's home country.
Offshore: Also known as an international merchant account, an offshore merchant account is located outside the country of the merchant.
High-risk: A high-risk merchant account is intended for online businesses with a high percentage of chargebacks and returns.
- Third-party: Connected by an additional secure payment gateway to a direct credit card payment processor, a third-party merchant account contributes to the work of the processor, sharing its expenses. This type is ideal for beginner e-commerce companies.
Generally, merchant transactions are not posted to the account at the time of purchase or refund. These transactions are usually posted in a batch during the merchant's settlement process. Depending on the business and the specific payment gateway, the settlement process can either be manually initiated or automated to occur at a specific time of day.
How to get a merchant account
To get a merchant account, a business must apply and be approved. Credit card companies guarantee that a cardholder is entitled to receive a promised good or service – i.e., if the good or service is not delivered, then the cardholder is entitled to their money back. As one of the most basic consumer-protection principles, this also mitigates the risk that the credit card processor faces. The payment processor has the potential to lose money every time it processes a credit card transaction for your business. Thus, all businesses that want a merchant account must apply, and sometimes there is a fee for this.
It's important for businesses to stay grounded in reality when applying for these merchant accounts. When you apply, your prospective processor should be able to provide clear answers on the type of documentation required and how long the approval process might take. If the processor makes unrealistic blanket promises or statements, it's good to be skeptical and take a closer look at the company.
When applying for a merchant account, it's important to have your financial documents in order to leverage the best possible terms of approval. A strong processing history is another valuable tool that you could use to leverage your application. You can use an old-fashioned cover letter to explain exactly what your business does and why it deserves a merchant account.
What fees are charged for merchant accounts?
The fees associated with a merchant account vary by provider. In some cases, merchant accounts adhere to a fixed per-transaction rate, which come without any additional fees. Others use an interchange-plus pricing model, which is the credit card company's processing fee plus the merchant account provider's markup. Finally, there is the tiered pricing model, which offers several different rates depending on the type of transaction.
Here's a closer look at each model.
Flat-rate pricing: Most commonly employed by mobile credit card processors, the flat-rate pricing model is simple to understand. For every transaction processed, you are charged a fixed percentage. For example, every time you swipe a debit or credit card, the processor might take 3% of the value of that transaction. This model is best for businesses with low sales volume or small-ticket items.
Interchange-plus pricing: This is one of the most common pricing models for small businesses. The interchange rate is the processing rate that the credit card company sets. In interchange-plus pricing, a payment processor will charge this rate plus a markup as its profit. For example, an interchange-plus pricing structure might appear as "2.75% + $0.10 per transaction." The 10 cents in this example is the processor's markup, while the 2.75% is the interchange rate.
- Tiered pricing: Tiered pricing breaks down transactions into three categories – qualified, non-qualified and mid-qualified transactions. Qualified transactions receive the most advantageous rate, while non-qualified transactions are the most expensive. The types of transactions in each category vary, but you can generally expect a card-present transaction at the point of sale with a regular credit or debit card to be a qualified transaction, while a keyed-in credit card number over the phone would usually be non-qualified. Mid-qualified transactions could include keyed-in card numbers with the use of an address verification service (AVS) to verify the cardholder's address for added security.
These are some additional fees beyond the pricing models:
Monthly fee: Sometimes referred to as a statement fee, the monthly fee is charged for the preparation of your monthly statement and the provision of customer support.
Gateway fee: If you require a payment gateway for card-not-present or online transactions, you might incur a monthly gateway fee.
Monthly minimum fee: Some payment processors have a minimum number or value of transactions you must complete each month. If you fail to meet this minimum, you could be subject to a monthly minimum fee.
PCI compliance fee: The Payment Card Industry has data security regulations to reduce the threat of identity theft and fraud. Many payment processors will help you stay compliant as part of setting up and maintaining your merchant account. Some processors charge PCI compliance fees for these services, but they aren't always disclosed when you inquire about pricing.
PCI noncompliance fee: Some processors charge fees for businesses that do not comply with PCI standards. Usually, you have a few months after signing up to come into compliance, and if you fail to do so within that timeframe, you could begin incurring PCI noncompliance fees.
Batch fee: You might be charged a batch fee when you post a batch of new transactions, which is usually once or twice in a day. These fees are usually the same as your per-transaction fee, about 10 to 25 cents.
Address verification service fee: If you use AVS to confirm a cardholder's address, you might be charged this fee by the processor. AVS is a fraud-prevention measure most commonly employed by e-commerce businesses and companies that frequently perform keyed-in transactions.
Retrieval fee: You might be charged a retrieval fee when a customer disputes a charge and their bank requests the records related to the sale in question. This isn't the same as a chargeback fee; the retrieval could ultimately prevent a chargeback if the customer's dispute is invalidated.
Chargeback fee: Chargeback fees occur when customers successfully dispute a charge and demand a refund. Chargebacks involve canceling an already processed transaction and returning the funds to the customer. You then have to pay a fee to the processor to cover the processing costs associated with the refund.
- Cross-border fees: International transactions generally come with additional fees to cover the costs of exchanging currencies electronically.
Some fees are unavoidable, but not all are common across credit card processors in the industry. Do your due diligence to be sure you aren't caught up in bogus fees from a shady payment processor.
If you want to accept credit cards, you need a merchant account
The bottom line is if you want to accept your customers' debit and credit cards, you need to secure a merchant account. In today's world, most customers expect the ability to pay with card; many don't even carry cash on a daily basis. Refusing to set up a merchant account so you can accept these forms of payments could upset your customers and ultimately lose you business.
If you're looking for a payment processing partner that can set you up with a merchant account quickly and easily, consider Business News Daily's best picks. These payment processors offer exemplary service to suit the needs of any business – see if the right fit for you is already on our list!
Elaine J. Hom and Sara Angeles contributed to the reporting and writing in this article.