Whether you’re a new business that has never accepted a credit card before, or are trying to gain a better understanding of the latest developments in payment processing, like NFC and MobilePay, this guide will answer your questions. 

Since payment processing has a direct effect on your revenue, it is especially important to make informed decisions. The payment processor you choose affects everything from your ability to collect payments, to your customer service, to your business’s bottom line. 

A few of the main topics we’ll cover include:

You’ll have the knowledge and confidence to decide if you need a payment service provider or a merchant account and how to negotiate a contract with a payment processor.

Understanding Payment Processing

As a business owner, you likely have a general understanding of how credit and debit cards work. But you need to understand what goes on behind the scenes to understand the pricing structures and security features of payment processors that we will go over in later sections. 

Simply put, a payment processor is a company that processes a transaction by conveying data between you, your bank account, and a customer’s bank account.

  1. When a customer pays with a credit card, the payment processor takes the input of the card’s information and passes it to the credit card network.
  2. The credit card network then checks with the bank associated with the credit card (the issuing bank) to ensure that there are adequate funds for this transaction to be completed.
  3. After adequate funds are confirmed by the credit card network, the payment processor sends the network’s approval back to you so you can complete the transaction. This process takes only a matter of seconds, but the job of the payment processor isn’t quite over.
  4. Later on, the payment processor still has to transfer the transaction amount from the customer’s bank account to your account (the acquiring bank).

This is a simplified account of a very complex process. There’s a lot more that goes on beneath the surface of a transaction, but you don’t need to know every detail of how it works.

Just remember that there are a lot of parties involved in a transaction – you, the processing company, the issuing bank, and the acquiring bank – and the job of the payment processing company is to enable accurate communication of data between all parties. 

Types of Payment Processing Accounts

As you’ve probably figured out, you can’t just start accepting credit cards without setting up an account. But you can only use your traditional business bank account to accept cash and checks; if you want to accept other forms of payment, you’ll need a merchant account in addition to your traditional business bank account.

You might wonder why can’t just link your business bank account with a payment processing company. Remember all the parties involved in a transaction? A traditional bank account is a repository for money; it doesn’t have the capabilities to verify and authorize the transfer of funds across so many networks.

You have the option to choose between two different account types:

  1. Traditional merchant account
  2. Payment service provider

Traditional Merchant Account

A merchant account is an account that allows you – the merchant – to accept debit, credit, and electronic payments.

It is also known as a settlement account, where funds from a transaction are held after they’ve been processed before they are transferred into your bank account. You don’t have direct access to the merchant account, rather, the funds from settled transactions are usually transferred to your bank account in 1-2 days.

A merchant account also comes with payment processing services, provided by the same payment processing company that sponsors your merchant account.

A traditional merchant account is the best option if your business collects a high volume of electronic or credit card sales, generally over $5,000 per month. Because of general pricing structures, you get a better value when you process a large quantity of transactions.

Merchant accounts are full service. For this reason, they often charge fees which you should be aware of. See the costs section below for more details. 

Payment Service Provider (PSP) Accounts

This type of account differs from a traditional merchant account in that you – the merchant – do not open a unique merchant account. Rather, the PSP lumps all users into what is essentially one giant, shared merchant account (also known as an aggregator account).

A payment service provider account is less complicated to set up than a traditional merchant account. A PSP gives instant account approval and doesn’t require any lengthy application. This brings down costs and allows the PSP to avoid having to collect all the fees of a merchant account. 

Effectively, PSP accounts are simple and affordable alternatives to traditional merchant accounts, especially for smaller businesses or businesses whose customer base largely pays in cash and check. Their processing fees are flat-rate, which is typically higher than those of traditional merchant accounts. But without the fees, a PSP can save a small business money. 

PSP accounts have disrupted the payment processing industry, and chances are you’ve heard of some of the largest PSP providers – such as Square, Stripe, and PayPal.

Related: Best Free Merchant Accounts

However, they might not necessarily be the best choice for your business. PSP’s are not full service, and typically lack client support. PSP account processing rates are non-negotiable, so as your business grows, you will likely prefer to pay the traditional merchant account fees and less for processing. 

Payment Service Provider or Merchant Account?

If you’re a small or very new business, you might not know whether accepting credit cards will actually increase your sales. If this is the case, get set up with a payment service provider, rather than with a merchant account that offers more complex pricing structures. A PSP allows you to get started with payment processing at almost no upfront cost. 

However, if you’re getting serious about versatility and you want a full-service merchant account, we highly recommend that you shop only for interchange plus pricing.

No matter how knowledgeable you are in the realm of payment processing, there are almost always a few confusing and unexpected hidden fees. The transparency of interchange plus will help you sort through these fees, negotiate them with the processing company, and avoid them.

Tiered pricing structures are less regulated, lack transparency, and overall more obscure, which leaves you at a disadvantage when trying to figure out if you’re getting a good rate.

Do You Really Need to Accept Credit Cards?

The short answer is that you don’t have to…but you should.

Whether you go with a merchant account or a PSP, your business will benefit from offering customer’s payment options beyond cash and check. And with the ease and low cost of setting up a PSP, there isn’t really a reason to not accept credit cards. 

Benefits of Payment Processing to Merchants

Today, upwards of 80% of consumer spending is cashless. People don’t walk around with wads of cash in their pockets anymore, and nobody wants to make extra trips to the ATM before going into a store.

Accepting cards translates to more money in your bank account because you open the door to consumers that pay exclusively via credit and debit card. As your customer base increases, so does your cash flow.

With payment processing, you don’t have to wait for a check to clear at the bank. Instead, you can have all proceeds from your sales deposited into your business bank account within a couple of days. 

And don’t forget, by opening a merchant account you will be able to more easily pivot your business to online sales if you so decide. In our world of rapidly evolving technology, more and more sales are moving online.

By embracing technology, you will be more able to level up with the competition. Here are some other reasons that you should consider payment processing.

Improved Customer Service

For customers, cards are less of a hassle than cash on many levels. There’s the huge convenience factor of not having to count out change, which expedites checkout lines.

On a psychological level, making purchases is less stressful when the customer can’t see the money leaving their possession. This encourages impulse buys and more purchases overall; there’s less of a chance that the customer will think twice before making a purchase. 

In response to the 2020 Coronavirus pandemic, many people feel uneasy about the physical exchange of paper money and the potential transfer of bacteria and viruses. Card and electronic payment involve less physical contact. Considering this, some business owners have chosen to go entirely cashless. 

The Cost of Payment Processing 

All the benefits of payment processing come at a cost, and what that cost is depends on many factors.

To understand the fees that you will pay as a merchant, and to read a merchant services statement, you need to understand what the fees are and where they come from.

Payment Processing Fees

Interchange Fees

Interchange is a wholesale fee that your bank must pay to the credit or debit card’s issuing bank for every transaction. These fees cover the handling costs, anti-fraud measures, and the costs of the risk involved in approving the transaction.

Interchange is the cost of credit card processing, and it makes up most of the fees you pay whenever you accept a card as payment. Unfortunately, interchange fees are non-negotiable, because they go to the card’s issuing bank, rather than to the provider of the merchant account.

No payment processor can give you a better deal on interchange fees, so never believe a salesperson that claims they have better interchange rates than other processing providers. 

Interchange qualifications are the determinants of interchange fees. Every card provider (Visa, MasterCard, Amex, etc.) categorizes the qualification level of a transaction differently, and the qualification level ultimately determines how much you, the merchant, will pay for that transaction.

More qualified and secure transactions have lower fees. For example, a swiped card is more qualified than a keyed-in transaction or a transaction where the card is not present. You might pay 0.80% for a swiped Visa card, but 1.65% for a keyed in Visa card. 

The major qualification determinants include the processing method of the card, whether the card is present, your merchant category code, the card type and brand, and whether the card owner is an individual or a corporation. Visa and MasterCard (the world’s largest card networks and the cards that you will process most frequently) both publish their interchange qualifications

Assessment Fees

Assessment fees are also wholesale fees that go to the credit card’s issuing bank. These fees are significantly less than interchange fees. Because the issuing bank doesn’t make any money from interchange, the assessment fees are used to levy the cost of issuing the card. 

Assessment fees are non-negotiable, so don’t let any salesperson tell you otherwise. 

Markup

So how do the payment processors make money? The payment processing company adds a small markup – also called a discount rate – above and beyond the fixed costs of interchange and assessment fees.

The markup differs from processor to processor. This is the rate that can be negotiated

Scheduled & Incidental Fees

Scheduled fees are derived from the processor’s markup, while incidental fees are generally derived only from the wholesale cost of the transaction. Any fees derived from the processor’s markup can be negotiated. Scheduled fees are those that appear regularly on your statement and cover the processing company’s operating costs.

Incidental fees may result from a penalty – such as not meeting authorization requirements – or from a credit card chargeback.

Always look for processors that are transparent with their fees, so you know what you can negotiate, and so that there are no unwanted surprises on your statement. 

Payment Processing Pricing Structures

Payment processing price structures are not created equal. Before you shop around for payment processing companies, figure out which pricing structure is best for your business. 

Interchange Plus Pricing

Interchange plus pricing is usually the lowest-cost and most transparent pricing structure. This makes interchange plus an excellent choice for most businesses.

The fee structure for interchange plus has two parts:

  • Interchange Fee – the wholesale processing cost which gets passed through to the merchant.
  • Markup Fee – the “plus” is the markup that the processing company adds to the wholesale cost. The markup applies to each transaction. It consists of a percentage fee and a per-transaction markup. 

Interchange plus is the most transparent pricing model because processors itemize the wholesale fees and markups in your monthly statement. This allows you see how much of a markup the processing company charges. You will know exactly which type of transaction costs you the most money, so you can discourage that form of transaction.

The downside to interchange plus is that your statements can be unpredictable. When each transaction has a different qualification, the processing fees that you pay may vary from month to month. 

Tiered Pricing 

With tiered pricing, each transaction falls into a category of qualified, mid-qualified, and non-qualified. As described above, if characteristics of a transaction put that transaction into a non-qualified category, then the transaction will cost more. Here are some example prices for the three categories.

CategoryRateTransaction Fee
Qualified1.75%20¢
Mid-Qualified2.25%25¢
Non-Qualified2.95%30¢

In theory, a large company might save money by electing a tiered pricing model, assuming that most of its transactions fall into a qualified category. However, tiered pricing structures are not regulated, and payment processors have been known to use questionable practices to move transactions into a less-qualified bracket.

Downgrading occurs when a transaction is moved into a higher processing fee tier. Because of lack of regulation, payment processing companies that use tiered pricing models are the least transparent because they downgrade transactions to increase their own profits for various reasons out of the merchant’s control. 

Getting the lowest rates with a tiered pricing model can be tricky. Most credit card brands update their interchange guides twice a year, but some payment processors intentionally do not update their systems. This makes it more challenging for merchants to know what markups they are paying to the processor.

When a salesperson pushes a tiered pricing structure, it is important to maintain a healthy level of skepticism. 

Flat Rate Pricing

This is the pricing structure of most payment service providers, such as Stripe, Square, and PayPal. The markups are higher than what you would pay with interchange plus because there are few to no scheduled and incidental fees beside the transactions.

With few upfront costs, this pricing structure is a good option for a small business that does not yet have the means to set up a traditional merchant account. 

Finding the Right Price Point

How do you know if the payment processing company is overcharging you? And how do you know if payment processing is even worth it? 

The easiest way to answer these questions is by calculating your effective markup rate, which can be found by dividing the total fees paid you paid to process your sales, by your total sales volume. This will tell you what you pay for credit card processing, including both wholesale fees and the processor’s markup.

The effective markup rate is expressed as the average percentage you pay to process a single card transaction, and will show the true cost of payment processing. When calculating the effective markup rate, the pricing structure does not matter.

You can compare the effective markup rates from interchange plus, tiered, and flat rate pricing structures side by side. This makes effective markup rate the best tool to cut through any fluff or sales tactics thrown at you by the salespeople at payment processing companies.

Calculate Effective Markup Rates with a Quote

Luckily, an accurate estimate of your effective rate can be calculated with just a quote from the processor and your forecasted sales. 

So, imagine that you are given a quote for an interchange plus pricing model, where your transactional rate and fees are 0.20% + 7¢ per transaction. You also know that the monthly fee is $30, the scheduled annual fee is $170, and other monthly fees amount to $10. 

calculate effective markup rate

Click on the spreadsheet above to open it while we walk through how to calculate the effective markup rate. You can make a copy and fill in your real data to help compare quotes from competing processors.

In this example, your forecasted monthly volume of sales is $10,000, and the average transaction amount is $150. 

First, you take the markup rate of 0.20%, and multiply it by $10,000, to find that your monthly discount is $20. 

Find the average number of transactions per month with 10,000/150, or about 67 monthly transactions. Because the fee you pay for each transaction is 7¢, you multiply .07 by 67 to find that you will pay about $5 in per-transaction fees per month. 

Then, add up all the scheduled monthly fees, and the annual fee of $170/12. This comes out to about $14. The fees that you should expect to pay monthly are $20 + $5 + $30 + $10 + $14, or $79 per month. 

If your estimated sales per month are $10,000, then your effective rate is your total fees of $79 divided by $10,000, or 0.79%. For the sake of the example, this is a fantastically low rate, and you’d be hard pressed to find such a deal in real life.

As a rule of thumb, a good and realistic processing rate falls between 2% and 3.5%. However, what a “good” rate is depends on the size and number of transactions you are processing. It is also important to remember that rate and fee quotes do not include incidental fees, which can range anywhere from ten to a few hundred dollars per month. Because you never know what incidental fees will occur, leave a little wiggle to account for this extra cost when searching for quotes. 

How to Choose a Payment Processor

You now have a good understanding how payment processing works, and how to compare by effective markup rate. But price isn’t the only determinant of value for payment processing.

In this section, we will discuss the key features that you should pay attention to when shopping for the right payment processing company to work with. 

Client Support

Payment processing is a service, so you should not overlook client support. There will inevitably be times when you need to discuss an unexpected fee, call about a missing deposit, or have a technical issue with your hardware.

Time is important in most of these occurrences. If you have to wait in an hour-long queue or your service representative doesn’t have the knowledge to help you, you’ll end up feeling left to your own devices. With the complicated systems of payment processing, you want to have a supportive team standing behind you. 

You can avoid ending up with poor service experiences by preemptively testing the client support before you sign up with a merchant account. To do this, you should first read all unbiased online reviews for any given processing company. And no, don’t read the testimonials on the processors company website. Ask other merchants that you trust which processing company they use. Referrals are one of the best ways to find yourself in good hands. 

Once you’ve found a processor with good references and reviews, don’t be afraid of calling them to test the general wait time to speak with a representative, and the expertise levels of the representative.

Do they have dedicated technical representatives? Can they answer your questions? Are they friendly and helpful? These factors contribute to the value of the processing service that you pay for. 

Security

One of the greatest and most legitimate concerns that business owner’s voice regarding payment processing is security. Here are a few important security features that you should look for – and understand – before deciding on a processing company. 

We’ve all seen the news of data breaches, even among giant retailers. But cash isn’t perfect in terms of security either. First, cash is a liability in that it can be lost or stolen, and it can leave you worrying about counterfeit bills. Cash increases the chance of theft, which can put you and your employees at risk. For this reason, some businesses, such as many gas stations, don’t accept cash at all. 

If you do your due diligence, most payment processing companies are highly secure. And new security software makes payment processing safer than ever. Chip card technology, also known as EVM (Europay, Visa, Mastercard) is a 10-step process with end-to-end encryption that makes counterfeiting almost impossible.

PCI Compliance

PCI DSS, or The Payment Card Industry Data Security Standard, is required for all businesses that accept credit or debit card payments. To become PCI compliant, there is an audit of 300 requirements that cover everything from firewall systems to your information security policy.

Fortunately, many payment processors take care of the PCI compliance for you. You should check that your processing provider will handle most of the burden of the PCI compliance process, especially because you will likely find an annual PCI compliance fee on your statement from the processor.

Many PSP’s, such as Stripe and Square, make it clear on their websites that they will populate the PCI audit for you, acting as your PCI validation advocate.

EVM Compliance

We briefly mentioned EVM technology above. EVM, or chip technology, creates a unique transaction code with every use. When the UK adopted EVM standards, fraud decreased by 70%.

The magnetic stripe, which is still found on most credit and debit cards, uses the same transaction code with every swipe. If that code is replicated, then it can be used over and over, whereas the transaction code on a chip card is rendered obsolete after its one-time use.

Your payment processor should integrate with chip-processing hardware. Fortunately, EVM standards are so widespread that most payment processing companies do integrate with EVM. 

Tokenization

Tokenization is an information-protection feature that replaces customer data with a randomly generated string of characters (called a token). A payment processing company that prioritizes security will use tokenization – rather than encryption – because tokenization permanently replaces the customer information with a token.

The tokenization process renders hacking virtually impossible. Look for processors that use tokenization as a security feature. 

Integrations

Chances are that besides accepting from credit and debit cards, you will want to offer online payment or payment via mobile app. By choosing a processor that integrates with all the hardware and software that you require, you can keep customer data on the same network – and the fewer networks that information has to pass through, the lower the likelihood of a security breach.

If your processor doesn’t allow for online payments, you may have to work with another processor, which just means that you’ll be running transactions through even more networks. You should minimize points of failure if you can, by only working with a single, versatile processor.

Reliability

Although most proceeds from your transactions are transferred from your merchant account into your business bank account within a day or two, there’s always a chance that an issue could occur which would prevent you from collecting your money for an extended period.

There are several instances that could cause your funds to be withheld. Usually, a processor withholds funds for security reasons.

  • Fraud / Chargeback: If they suspect any kind of fraud or a potential chargeback – which is when a charge is disputed by a customer – then the money won’t leave your merchant account until they settle the dispute.
  • Rolling Reserve: In order to protect themselves, processors will implement a rolling reserve by holding a percentage of your earnings as a guarantee, and then releasing those funds after several days.
  • Account Freeze: In the worst cases, a processor determines that your business is high risk and consequently freezes your account. An account freeze will prevent you from processing further payments, and may ultimately result in the termination of your account.

Therefore, much of the reliability of a processing company is written into the contract. Pay attention to the specified days that your funds can be withheld and what percentage of your earnings will be held if your agreement calls for rolling reserves.

Finally, make sure that the processing company does not consider your business to be high risk; every processing company has generally designated a level of risk to each merchant code. Don’t enter into a contract with a processing company that is liable to freeze or terminate your account, which could cost you money and leave you with a giant headache. 

Value-Added Products

Deciding which value-added products you need is as easy as knowing which platforms you want to sell your products or services. Online or face to face? Mobile or storefront?

After you figure out what value-added products you need, you can look for processing companies that offer solutions for and integrations with your hardware and software. 

Point of Sale (POS)

POS is a general term for the hardware and software that you – the merchant – use to process transactions. A POS usually includes a credit card reader paired with a computer that can run your payment processor’s software.

A POS may also have a cash drawer and a receipt printer, as well as more advanced features such as an electronic menu, the ability to adjust and manage inventory, sales data, and customer accounts.

Some payment processing companies give you the option to rent, lease, or buy the POS hardware. Typically, a basic credit card reader starts at about $200, but more sophisticated systems can go upwards of $1000.

Renting the hardware can be a good option if you’re not entirely sure that you want to continue to process credit cards, or if you need but can’t afford more sophisticated hardware.

However, leasing hardware should be avoided. Most leases cannot be cancelled even if you cancel your contract with your payment processor. And, you’re still liable for any damage done to the hardware. 

Don’t forget to consider NFC payments, which stands for “Near-Field Communication.” This is the technology that enables ApplePay and Google Wallet, and it’s a fast-growing trend in methods of payment because people don’t have to pull out their wallets.

You can get an NFC reader as an add-on to your POS, though some card readers come with this technology already built-in.

E-Commerce

If you plan to sell online, you need a payment gateway. A payment gateway connects your ecommerce store or website to the payment processor, and should do so with a high emphasis on security.

When a customer makes a purchase on your website and enters their payment information, it is the job of the payment gateway to securely transfer this information to the payment processor. Many payment processors will provide you with a payment gateway for an additional fee, and some payment gateways will integrate with your POS.

Ecommerce is becoming increasingly lucrative, so look for payment processors that will offer reasonably priced payment gateway services. 

How to Shop Around

It’s finally time to get started with payment processing. And that means you have to do a lot of shopping around.

In this section, we’ll go over a process for collecting and analyzing quotes that makes shopping around more efficient. 

  1. First, make a list of references for processors, or find payment processing companies with excellent reviews.
  2. Then test the customer service out yourself by calling the customer service representatives to ask if they offer interchange plus pricing, as well as which value-added products they offer and integrate with. Pay attention to phone wait times and how knowledgeable the staff is.
  3. From the list, cross off the companies that fail to provide adequate service and that do not offer the value-added products you need, or will need in the future. 
  4. When you’ve found a few promising companies, it’s time to deepen your inquiries. Call again and ask for their processing rates as well as their scheduled and incidental fees. A good company to work with will be transparent about pricing.
  5. Examine all of the fees for each payment processor. Start by separating the raw wholesale costs (the interchange and assessment fees) of the transactions from the processor’s markup. Use the numbers provided to calculate each processor’s effective markup, which we covered above. It is very important to do your own effective markup calculation because salespeople will often quote you a lower effective markup rate than what you will actually pay. Usually they do not include incidental fees in their calculations. 
  6. Use the effective rate to make side-by-side comparisons of all your prospective companies. Pick the company with the best rates, good transparency, and that satisfies a holistic assessment of overall value. 

Negotiate Payment Processing Agreements

This is the fun part. Okay, it can also be a little stressful. These are some negotiation tips that will give you an edge and help you dig for the best rate possible. 

  • Remember which rates are negotiable. Wholesale fees are non-negotiable, which also means that the payment processors are lying if they claim that they can give you lower interchange rates than the competition. They can, however, give you lower rates on their markup. Always focus on reducing the effective rate. If you have already been processing credit cards and are looking for a lower rate, leverage your effective rate to find better deals.
  • Pay attention to hidden fees. Ask the processor for a comprehensive list of all possible fees – particularly incidental and one-time fees. These might include statement fees to cover the cost of mailing your statements, fees for not processing enough transactions if you’ve had a bad month, and early termination fees. 
  • Get a month-to-month agreement. Some processors start their contracts at one year or more. Always try to get a month-to-month agreement, which will open up the opportunity for you to negotiate better rates with your current processor, and switch processors if they don’t work with you. 
  • Don’t get pressured into a bad deal. Salespeople work on commission, so it’s understandable that they might use some pushy sales tactics, like selling you on a limited time offer that doesn’t really exist. Focus on the numbers, and whether they work for your business. Gimmicks such as free hardware, could turn out to be legitimate offers, but they shouldn’t carry much weight in your decision. In the long run, the largest expenses will come from fees and the processor’s markup. 

Merchant Account Application Process

Now that you’ve chosen a payment service company to work with, you still have to go through an application process.

While the application for payment service providers is straightforward and approval is instantaneous, the application process for a traditional merchant account can take two to three business days, assuming that you have all of your documents in order.

To expedite the process, it is helpful to know what you need for your application beforehand.

Proof of Entity

Usually, any federal or state issued document can be used to establish that you are a real, registered business. Sufficient documents may include your business license, articles of incorporation, recent tax return, or sales tax registration. You may need one or more of these documents, so it can be helpful to have all of them on hand. 

Completed Application

The actual application can usually be completed within an hour. If you have a business partner, the application is not considered complete until it has both of your signatures, or the signature from an authorized representative on behalf of all the partners. 

Business Bank Account

Proof that you have a business bank account is always required. This proof can come in the form of a voided check, or a signed bank letter that includes your checking account number, the legal name of your business, and the routing number. 

Additional Documentation

Because the intent of the application is largely to indicate the level of risk that the processing company will take on when they accept you as a client, they may need additional information. And risk is largely based on the number of transactions, the average transaction amount, and what type of products or services are being sold. Be prepared to answer rather detailed questions about your business operations. 

Final Word on Payment Processing

Getting started with payment processing is a hurdle at the beginning. But it will absolutely pay off with increased cash flow, a better customer experience, and a wider base of customers overall.

Once you set up your payment processing system, many doors will open. Your goal in this process is to find the best rates without sacrificing security and service quality.

The Balance has a great list of payment processors and merchant accounts that will help you find the best provider for your business.

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