How does online payment processing work?

PayPal Editorial Staff

PayPal Editorial Staff

September 29, 2022

Hand holding a phone that shows a payment processing confirmation of "Success"

As online shopping increases, many businesses are setting up digital shops to accept payments online and capture more sales. But after a customer hits "check out," how does the money get you?

Whether you’re expanding a brick-and-mortar business to accept payments online or starting a new venture from the ground up, it’s important to understand how online payment processing really works—who's involved, how you get paid, and processing fees. That way, you’ll be prepared with a plan that works best for you and your business.

What is online payment processing?

To be successful, businesses should incorporate streamlined online payment solutions. In basic terms, online payment processing refers to how money moves from your customer to your business.

Though this may sound simple, many moving parts are involved in processing credit and debit card payments, whether online, via phone sales, or even in person. On one end is you, the business owner or merchant account. On the other end is your customer. And in between is a lot of technology that connects the two of you.

The merchant

When accepting payment online, the merchant is considered you or your business. However, to accept credit and debit card payments from online customers, you will likely need to partner with one of the many available merchant account providers, including our PayPal merchant account.

This merchant account (sometimes called an acquirer) accepts payments on your behalf and deposits them into a business merchant account they provide. For instance, you can accept online payments with PayPal.

The payment processor

Payment processors (or merchant account services) handle all the heavy lifting in online payment processing, from moving the transaction through the processing network to sending you a billing statement, and then working with your bank to ensure you get paid. Often, your merchant bank is also your payment processor, which helps simplify things.

The payment gateway

One of the technologies involved in online payment processing that enable you and your customer to transact is the payment gateway. For us, it’s called the PayPal payment gateway. This is software that links your site's shopping cart to the processing network.

The customer

For your customer to pay for your goods and services, she needs a credit or debit card. The bank that approves her for the card (and lends her the cash to pay you) is called the issuing bank.

How does online payment processing work?

As a business owner, it’s helpful to understand exactly how money moves from your customer to your business. There are two stages to online payment processing: the authorization (approving the sale) and the settlement (getting the money in your account).

The authorization process goes roughly like this:

  1. Your customer buys an item on your site with a credit or debit card.
  2. That information goes through the payment gateway, which encrypts the data to keep it private and sends it to the payment processor.
  3. The payment processor sends a request to the customer’s issuing bank to check to see if they have enough credit to pay for the item.
  4. The issuer responds with a yes (an approval) or a no (a denial).
  5. The payment processor sends the answer back to you that the sale was approved and also tells your merchant bank to credit your account.

In terms of online payments, all of the above takes place within one to two seconds.

The second piece of the online payment system process (where you get paid!) is the settlement:

  1. The card issuer sends the funds to your merchant bank, which deposits the money into your account.
  2. The funds are available.

The settlement process can take a few days. Sometimes, your bank lets you access your money before it’s even sent to them. They also may keep a portion in your account that you can’t touch, just in case the customer returns the item later (called a reserve in payments speak). Check out our step-by-step guide to PayPal payment processing.

Payment processing pricing and fees

We’ve learned about how payments come in, but what about the other side of the coin? What will it cost? As you may have guessed, everyone who touches the transaction wants to get paid, including the issuing bank, the credit card association (Visa, MasterCard, etc.), the merchant bank, and the payment processor.

At its most basic, every time you process a sales transaction, you pay four payment processing fees:

  • A percent of the transaction amount: The issuer gets paid by taking a percentage of each sale, called the interchange. This fee varies depending on various factors, such as industry, sale amount, and type of card used.
  • Another percent of the transaction amount: The credit card association (Visa, MasterCard, etc.) also charges a fee, called an assessment.
  • Yet another percent of the transaction amount: Your merchant bank takes a cut by charging you a percentage fee. The amount here also varies by industry, amount of sale, monthly processing volume, etc.
  • A dollar amount for every transaction processed: The payment processor (who might also be your merchant bank) makes money by charging a fee, called an authorization fee, every time you process a transaction (whether it’s a sale, a decline, or a return—no matter). Plus, it can charge fees for setup, monthly usage, and even account cancellation.

Usually, the first three fees (the percentages) are all added together and quoted as a single rate, while the transaction fee is quoted separately (e.g., 2.9% + $0.30).

Most pricing structures generally fall into one of three categories:

  • Flat-rate pricing: You pay a fixed percentage for all transaction volume, no matter what the actual costs are. All of the above fees are baked into this single rate. For example, you are charged a bundled rate of 2.9% of the transaction amount + $0.30 per transaction. On a $100 sale, the fee you pay works out to be $3.20.
  • Interchange plus pricing: Your merchant service charges you a fixed fee on top of the interchange. For example, 2.0% + $0.10 on top of a 1.8% interchange fee. On a $100 sale, that works out to be a $3.90 fee. Learn more about IC++ pricing.
  • Tiered pricing: The processor takes many different interchange rates and lumps them into three buckets (or pricing tiers): qualified, mid-qualified, and nonqualified. This makes it simpler for you (and them) to understand. However, because the processor defines the buckets any way it wants, it can be expensive. As an example, the fees you pay on a $100 sale could range from $2.50 to $3.50, depending on how it has been classified.

For more information, visit PayPal pricing.

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