How Credit Card Transactions Work
A lot of things happen between the time you swipe your credit card and sign the credit card slip. Everything that happens behind the scenes makes it possible for you to make purchases with your credit card instead of having to go to the bank every time you want to spend money from your credit limit.
A few people/entities are involved in each credit card transaction:
- The customer (you) presents the credit card for payment.
- The merchant sells you goods or services.
- The merchant's bank sends credit card transactions for approval.
- The credit card payment network is a liaison between the merchant bank and the credit card issuer.
- The credit card issuer approves and pays transactions.
Swipe Your Credit Card for Approval
You present your card for payment by inserting it into an EMV card reader, tapping it on the terminal for a contactless transaction, or swiping the magnetic stripe. The payment terminal communicates with the merchant bank to ask whether you can make the credit card purchase.
Most credit cards now come with microchip technology. These so-called "smart cards," or "EMV cards" (Europay, Mastercard, and Visa) embed a microchip on the front of the card that contains information pertaining to the account associated with the card, similar to what is contained in the magnetic stripe on the back of the card. Rather than swiping your card, it is inserted into the card reader. Introduced in the United States in 2015, smart cards are considered more secure and less vulnerable to fraud.
Credit Card Authorization
The merchant bank contacts the appropriate credit card network (Visa, Mastercard, American Express, or Discover) to get authorization for the credit card purchase. Then, the payment network contacts the credit card issuer to make sure the credit card is valid and there's enough available credit for the transaction.
American Express and Discover are the payment network and the credit card issuer, so they approve credit card transactions themselves. Visa and Mastercard, however, do not issue credit cards and must contact the credit card issuer.
The credit card issuer sends back an authorization response for the transaction. If your credit card is declined, you won't get a reason at the point of sale, just a message that the card was declined. You'll have to contact your card issuer directly to find out why your card was declined.
The store’s bank sends their communications electronically either through the phone line or through the internet. Before the widespread use of WiFi (Wireless Fidelity), you may have been to a store or restaurant and heard the screeching and static from the credit card terminal using a dial-up connection to communicate with the merchant bank. Now you know what all the noise was about.
Credit Card Approval
The merchant bank sends the approval message for your credit card purchase, the receipt prints, you sign, and you can leave with your purchase. When you use your card’s EMV chip, the merchant is not required to obtain your signature.
When you leave the store with your purchase, your credit card has only been authorized for the payment. The merchant hasn’t actually been paid and your credit card hasn’t been charged. If you check your credit card online right after you’ve made a purchase, the credit card issuer may show authorized transactions and may have reduced your available credit by the amount of your recent purchase.
Typically, at the end of the day, the merchant transmits a batched list of all the credit card transactions that have been made that day and sends them to their bank. Some merchants settle transactions individually in real time as they occur, rather than batching them for daily processing. The merchant’s bank then sends the transactions to the appropriate payment network for processing.
The Credit Card Issuer Sends Payment
The credit card network lets each credit card issuer know what payments are due. The credit card issuer keeps a fee, the interchange fee, as part of its agreement with the merchant, for processing costs and risk. Credit card networks charge an assessment fee to use the network.
The Merchant Gets Paid
The credit card network sends payment to the merchant bank who collects its own fee before depositing the credit card charges in the merchant's account.
The Credit Card Issuer Bills You
Each month, the credit card issuer sends a bill for the charges you made during the month. Then, you pay some or all the charges. If you choose to pay only a portion of the charges, you'll pay interest on the amount that you don't pay. The credit card issuer uses your balance and interest payments to reimburse merchants as new transactions are made.