From the blog What Is a Merchant Account and How Does It Work?
What is a merchant account? Spoiler alert. Even if you don’t know, you likely already have one.
A merchant account is the unique bank account that enables you to accept credit cards at your business right now. Merchant accounts also provide vital security protections for you and your cardholders, reducing the risk of data breaches, chargebacks and fraud.
In this article, we’ll break down what a merchant account is and how it works. You’ll also learn other helpful payment processing terms and how merchant account rates are calculated.
What is a merchant account?
A merchant account allows you to accept credit cards at your business. But there’s more to it than that.
On its own, a merchant account is an account that holds the funds from credit card transactions after they’ve been processed. The account itself is provided and maintained by a payment processor.
Here’s how a credit card transaction plays out when you have a merchant account.
A customer makes a purchase with their credit or debit card, and then a payment processor authenticates the transaction. The processor moves the funds from the customer’s bank account to your merchant account. After a certain amount of time, the funds are moved into your business bank account.
That means you won’t have direct access to the funds in your merchant account, but your business bank account is able to receive the fund transfers.
Related terms to know
A lot of effort has gone into making merchant accounts and credit card processing safer, easier and more transparent for business owners. Still, you’re bound to run into a few important technical terms that need explanation.
Understanding these terms helps you protect your business and gives you a great starting point to discuss solutions with your merchant account provider. Here are some terms you’ll want to know.
Acquiring banks, also called merchant banks or merchant acquirers, are the financial institutions that create and maintain merchant accounts. They also authorize (or reject) credit card transactions based on information from the cardholder’s bank—the issuing bank—and the card network.
Acquiring banks are different from payment processors. Payment processors provide the technical platform for transferring card data, along with many other merchant services. Some acquiring banks provide processing solutions, too.
Issuing banks, also called issuers, are banks that issue credit cards and debit cards to consumers. When a customer makes a purchase, issuing banks assess whether there’s enough money to cover the cost. If there is, they approve the transaction on their end, and the sales goes through.
One simple way to explain what happens during card transactions is that money is being transferred from the issuing bank to the acquiring bank.
PCI DSS compliance
Anyone storing, processing or transferring cardholder data must abide by the Payment Card Industry Data Security Standard (PCI DSS). The PCI DSS is a set of security standards created to ensure that everyone involved in card transactions is protecting sensitive data as best they can.
As a merchant accepting credit card payments, you must maintain PCI DSS compliance (often shortened to PCI compliance). Your payment processor or merchant account provider should provide you tools to help you maintain PCI compliance. As your business grows and changes, you’ll be required to meet increasingly higher levels of PCI compliance.
Point-of-sale (POS) hardware refers to the payment equipment—like credit card terminals and card readers—you use to accept credit and debit cards (and other payment methods).
You can rent or own your equipment. Some payment processors charge for equipment separately—others provide POS hardware at no cost. If you’re scaling your business, this can add up to significant savings.
You need to be EMV compliant to protect your business from fraud liability.
EMV stands for Europay, Mastercard and Visa, the global standard used for chip cards. You’re probably familiar with EMV chip cards due to the increasing number of cardholders using them—these are the customers sticking their cards into the card terminals rather than swiping.
In 2015, major card networks, like Visa, Mastercard, American Express and Discover, shifted EMV fraud liability to merchants. Now if a merchant’s payment equipment isn’t compatible with EMV chip cards when a fraudulent card transaction occurs at their business, the merchant is liable. If you don’t already have EMV-compliant POS equipment, we highly recommend that you talk with your payment processor.
There’s another term you’ll want to know, too: payment facilitators, often called PayFacs.
Merchant service providers vs. payment facilitators
Traditionally, dedicated financial institutions offered merchant accounts to businesses—we call these institutions merchant service providers.
Technology has shaken things up a bit. Now, there are PayFacs, which also provide merchant accounts and payment processing. If you’ve heard of Square, you know a PayFac. PayPal and Stripe are other popular PayFacs (for e-commerce payments).
The biggest difference between merchant service providers and payment facilitators is the level of account stability.
Like we discussed above, payment processors want to decrease the risk of providing merchant accounts. One way that PayFacs do that is through aggregation—pooling the funds of different merchants.
That means there isn’t as much attention given to individual accounts as with merchant service providers, leading to some well-documented issues with PayFacs. Small business owners have reported account holds, frozen funds and sudden termination for things like large transactions or an increase in average ticket size.
On the other hand, merchant service providers tend to offer more reliable customer support. They’re also a good solution if you’re growing or expecting to grow—for example, processing more than $5,000 per month in credit card transactions.
How rates are calculated
As we mentioned, many different financial institutions now offer credit card processing services—and with that comes an array of rate structures and fees.
When you were signing up for your merchant account, you likely saw this firsthand. One payment processor might advertise a 2.75% flat rate, and another may quote you 2.9% + $0.30 per transaction. What does this mean? We’ll go over the most common credit card processing rates and how they’re calculated.
Broadly, each time you run a credit card, you’re going to pay a few fees: interchange fees, the payment processor’s fees and assessment fees.
Payment processors package and present these fees differently, resulting in various rate structures. We’ll talk through the different fees and three most common pricing models.
Twice a year, Visa and Mastercard, the biggest card networks, set interchange fees. These fees are fixed no matter which payment processor you use—it’s the cost of running a card.
Interchange fees are written as a percentage of the sale amount plus a per-transaction fee, like this: 1.89% + $0.10. These fees differ based on factors such as:
- Customer’s payment method (card present or card not present)
- Whether a debit card or credit card was used
- Type of card (rewards card, business card, etc.)
- Equipment used to run the sale
- Business type (high-risk businesses have higher fees)
Generally, higher-risk transactions (like manually keyed credit card transactions) are more costly.
Payment processor fees
Payment processors charge fees to facilitate secure transactions and to cover the risks of processing payments.
The different credit card associations (Visa, Mastercard, American Express, etc.) charge assessment fees. Like interchange fees, they change yearly.
3 most common rate structures
As you can see, interchange fees are central to payment processing, so many payment processors base their pricing model on this fee. Each structure has pros and cons.
- Flat-rate pricing: You’re charged the same rate for every kind of card transaction. This structure is easy to understand but also makes it difficult to know what you’re being charged for each fee because they’re bundled together.
- Ex. 2.9% + $0.30 per transaction
- Interchange-plus pricing: This is regarded as the most transparent option and is favorable for many business types and sizes. The processor simply adds their fee (calculated as a percentage) on top of the interchange fee.
- Ex. 0.2% + $0.10 per transaction
- Tiered pricing: The processor creates buckets (pricing tiers) based on the risk level of the transaction. Generally, the three tiers are: qualified, mid-qualified and non-qualified. The qualified tier, for example, might include non-reward credit cards used with a terminal, so it has the lowest rates.
- Ex. 3% + $.0.25 for mid-qualified transactions
Whichever rate structure you’re on, your payment processor should be helpful in explaining fees, regardless of whether they’re broken out or bundled. Some payment processors even match competitors’ rates to give you the best value and service.
More tips on payment processing
A merchant account—and a fair credit card processing rate to go with it—is vital for a modern, profitable business.
Now you know the lingo and where this fits in with your business.