For customers, a credit card payment seems instantaneous, taking no more than a few seconds. But what appears simple on the surface involves a complex set of interactions between several players, resulting from decades-long efforts to streamline, facilitate, and handle the processing of credit cards.
To better understanding the mechanics of the credit card processing ecosystem, it’s important to first recognize the difference between three key terms: payment processing, payment gateway, and payment facilitator. These are arguably the most integral elements ensuring the transactions you handle for customers are passed quickly and securely.
Even those of us familiar with the payment industry can sometimes get mixed up with the abundant terminology. In this blog, we’ll help you understand the difference between these core terms and explore what you need to start accepting payments online. For a more comprehensive overview of how credit card processing technology can speed up and automate payments, read The Ultimate Guide to Credit Card Processing.
The lifecycle of a credit card transaction
When a customer initiates a credit card payment on your ecommerce site or at your point-of-sale (POS), several players are involved in facilitating the transaction and moving the money from the cardholder’s account to yours.
Essentially, the payment processor (the service provider facilitating the payment acceptance) receives and transmits the card information through the payment gateway (the technology that helps securely transmit the data), then coordinates its authorization and settlement with the card networks and banks, and finally funds the merchant.
Here’s what that process looks like:
- Step 1: The cardholder initiates the payment by presenting their credit card information via your website, POS terminal, or over the phone. Pro tip: an integrated payment solution that allows you to accept various payment methods from the same platform can help streamline this process.
- Step 2: The credit card processor that you’ve partnered with will then collect the credit card information and route it through a payment gateway to the credit card network (for example, Visa or Mastercard) to begin the authorization process.
- Step 3: The card network will reach out to the issuing bank (the cardholder’s bank, which supplied them with the credit card), which approves or denies the transaction. Approval means that the issuing bank has confirmed that the customer has sufficient funds to cover the cost of the transaction.
- Step 4: Once the issuing bank has approved or denied the transaction, that authorization will be relayed back to the processor via the card network. The transaction will be denied if funds are insufficient or if there is suspicion of fraud.
- Step 5: Once the transaction is authorized, the issuing bank will place a hold for the payment amount (the issuing bank is the one physically paying the funds and is later refunded by the cardholder with any applicable interest).
- Step 6: At the end of every business day, you—the merchant—will batch and send approved transactions for settlement via the payment processor.
- Step 7: The card network will forward the approved transactions to the issuing bank, which will release the funds to the acquiring bank, minus interchange fees. The acquiring bank is the bank your business is associated with.
- Step 8: The funds are deposited into your merchant account minus any interchange or processor fees and are later transferred to your business account.
On the surface, credit card transactions seem simple and relatively instantaneous, but behind the scenes there are many moving parts.
Payment processor vs. payment gateway: What’s the difference?
If you want to accept payments online (and there’s no better time than now to be doing so) you’ll need both a payment processor and a payment gateway. Note that both these terms are often mistakenly used interchangeably, and while they’re deeply interconnected, they in fact perform very different tasks.
A payment processor is the actual company that handles card transactions for a merchant, acting as the go-between for them, the banks, and the card networks. They support with capturing the payment information and forwarding it to the card networks and banks. The processor will often also sell or lease the payment terminal equipment used to accept payment at a brick-and-mortar location.
Payment processors can also support with payment methods beyond credit card, helping you offer your customers a diversity of payment options. It’s also important to remember that not all payment processors are created equally. The best payment processors out there can help reduce your cost of acceptance—in some cases as much as 40%—through interchange optimization.
A payment gateway creates a secure connection between a merchant’s ecommerce site and the processor. It encrypts the data that’s passed with every card transaction, verifies its authenticity, and ensures it’s sent securely.
The difference between a payment processor and a payment gateway lies in the fact that one—the processor—is the service provider facilitating the transaction, while the other—the gateway—is the communication channel responsible for securely transmitting the payment data to the payment processor and credit card networks.
Another critical difference is that for purchases made at a physical location, the POS terminal supplied by the payment processor is all that’s needed to verify the authenticity of a card, whereas in card-not-present transactions (like those made online), the payment gateway will authenticate the card before securely sending its details to the processor. Naturally, the riskier nature of card-not-present transactions makes security an utmost priority when verifying and transmitting card details.
Payment processors will often bundle all the services a merchant needs to accept payments, including equipment and support for setting up a merchant account.
In some cases, the payment processor will also have their own proprietary gateway. The value in this is that the processor can control the entire transaction flow rather than bringing in another third party.
What is a merchant account?
A merchant account is the type of bank account needed for a business to be able to accept credit card payments and represents an agreement between you, your bank, and the payment processor.
You can apply for a merchant account through your existing bank, but it’s often easiest to work with a payment processor to get one, as they can bundle this with the other services they provide and manage the entire application process for you. Different payment channels—in-store vs. online, for instance—will often require their own merchant account, so it’s important to partner with a service provider that can support all the payment channels you need.
What Is a payment facilitator?
When it comes to merchant account providers, there are two options: an Independent Sales Organization (ISO) or a Payment Service Provider (PSP), also known as a Payment Facilitator (PayFac). You may have also come across the term Member Service Provider (MSP), which is simply the term Mastercard uses in place of ISO (these refer to the same thing).
Both types of merchant account providers can support with your equipment and service needs. The difference between the two is that with an ISO you get your own merchant account, whereas with a PayFac you don’t. With a PayFac you are onboarded as a sub merchant under a larger account, saving you the trouble of applying for your own. Payment facilitators also help ensure a more seamless payment experience for customers and greater back-office efficiencies for sellers.
The application process for a merchant account requires considerable paperwork and can take several days or even weeks, which is a key reason why many businesses prefer to work with a PayFac. With a PayFac you can start accepting payments almost immediately and get more opportunities to integrate payment acceptance with other technologies, particularly when the service provider also owns the payment gateway.
Generally, a PayFac is a good fit for businesses that process less than $1 million in payment volume annually, whereas an ISO is well-suited for larger businesses that process more than this.
What do you need to start accepting payments online?
In addition to an ecommerce platform, to accept payments online you’ll need a payment processor, a payment gateway, and likely at least one merchant account. Working with a total merchant services provider like Versapay is the easiest way to get up and running quickly with everything you need to start accepting payments online.
With Versapay you can start accepting payments in as little as 24 hours from all your channels such as invoice, ecommerce, card-not-present, and point-of-sale, all integrating seamlessly with your enterprise resource planning system (ERP).
To learn more about the considerations you should take into account when researching and selecting a payment processor—from transaction speeds to customer support—check out our free resource, The Ultimate Guide to Credit Card Processing.