Merchant Processing Explained for Frustrated or Confused Merchants

Fun fact: there are more credit card accounts than people in the United States. With credit cards being so ubiquitous in our society, it’s no surprise that card is the preferred mode of payment for most American consumers. It’s essential for any business to accept credit and debit card payments if they want to succeed in today’s competitive market. Which is baffling for those of you that remember how common it was for you to find cash-only businesses.

Mobile processing changed the game.

If you’re a vendor, store, or establishment that doesn’t accept credit/debit card payments, you’re potentially losing out on hundreds to thousands of dollars in revenue. Considering that most businesses that open up fail, its no wonder businesses end up investing in getting a merchant processing account.

Whether you’re a startup looking for your first payment processor or an industry vet thinking about switching providers, here’s everything you need to know about accepting credit card payments and merchant processing.

What Is Merchant Processing?

Merchant processing, also known as credit card processing, is the process of authorizing and clearing a credit or debit card transaction. Any time a customer uses their card to pay you for your goods or services, the transaction has to go through merchant processing.

Even though the process takes only a few seconds, it’s actually a complicated operation that could involve half a dozen different parties. You can incur a variety of fees at each stage of the transaction, so it’s important to understand who you’re paying, what you’re paying, and why.

So who are the parties involved?


Also referred to as the “cardholder”, the customer is someone who owns a credit or debit bank card. This card is then used to pay you (the merchant) for your goods and services.


The term “merchant” can actually refer to any business as long as they offer goods and services. However, for the purposes of this article, we’ll limit the definition to business who accept credit card payments for those goods and services.

Merchant Acquirer/Processor

The merchant acquirer acts as the liaison between the merchant and the card association, card network, and others. They are often hired by the merchant’s bank or other financial institutions to handle the bulk of the credit card processing. Merchant processors deposit your earnings into your account, calculate your fees based on your quoted rates, and send your monthly merchant statements.

Card Association

There are four major card networks: Visa, MasterCard, American Express, and Discover. Credit card organizations dictate the interchange rates (more on that later) and work with the cardholder’s bank to authorize and settle transactions.

Bank/Card Issuer

The card-issuing bank, as the name implies, is the financial institution that issues cards to customers. All issuing banks are licensed members of card associations. When one of their cardholders makes a purchase, they pay the merchant’s bank. The cardholder is then responsible for paying back the issuing bank.

Payment Gateway

A payment gateway allows you to charge customers and collect payment online. Payment gateways perform a similar function to point-of-sale credit card terminals, except online. It adds an extra layer of security and protects the customer’s sensitive information. Directly transmitting transaction data to a payment processor is risky and prohibited.


Merchant Processing Terms You Need To Know

Monthly Processing Volume

Your monthly processing volume refers to the total amount of sales you made within a month.  F
or example: this month, you sold $1000 worth of goods/services that were paid for using a credit card. Your monthly processing volume is $1000.  Monthly volume is one of the biggest determinants of your processing fees.

Average Ticket Size

Another helpful figure is your average ticket size. This is the average price per transaction. You can compute your average ticket size by dividing your monthly processing volume by the number of transactions.

For example – your monthly processing volume is $1000. Your total number of transactions for the same period is 100. That means the average ticket size per transaction would be $1000/100 = $10.

Business Type

No matter what kind of business you run, your company will fall under one of several categories. Your business category will determine what kind of fees you will have to pay for merchant processing. Some business types, like hotel, travel & entertainment, e-commerce, or mail order/telephone order, (MOTO) have higher rates than others due to the higher perceived risk of the transaction.


Card-present refers to all transactions where the card was swiped, dipped, or tapped at the credit card terminal. This includes point of sale purchases, face-to-face transactions, and other similar situations. Card-present transactions have lower fees than card-not-present transactions due to the lower security risk.


Card-not-present refers to all transactions where the card could not be physically scanned. This includes purchases made over the phone, online/e-commerce transactions, or keyed-in transactions. Card-not-present transactions have a higher fee than card-present transactions due to a higher risk of fraud.

Address Verification Service (AVS)

Address verification service is an additional security step that is implemented on all card-not-present transactions, including e-commerce transactions, keyed-in transactions, and MOTO transactions. Before the card can be processed, the following information needs to be provided:

  • Credit card number
  • Expiration date
  • CVV/security code
  • Billing address
  • Billing zip code

The information provided will be cross-checked with the cardholder’s information on file with their issuing bank. This helps protect the customer, the merchant, and the banks from potential credit card fraud.


Interchange fees are set by the card networks, usually expressed as a percentage of the transaction plus a small transaction fee. Interchange fees comprise the bulk of the processing fees you pay every month. We go into great detail on this aspect of processing in our credit card processing fees guide.


Unlike the layman’s definition, “discount” in the credit card processing industry is quite different. This refers to the actual rate you are charged by the merchant acquirer to process your credit card transactions. The discount is made up of the bank’s interchange fees plus the merchant’s markup.


Authorization is the first step in credit card processing. When you swipe a credit card (or enter in its information at the terminal), the data is sent to the issuing bank. The issuing bank will check the cardholder’s available funds if there is enough to cover the purchase. If the cardholder has enough credit, the purchase is authorized. If the cardholder doesn’t have enough credit, the transaction is declined.


Chargebacks happen when a customer disputes a particular transaction. Merchants are penalized when a customer reports potential fraud. The disputed amount is taken from the merchant account until the dispute is settled. If the merchant cannot provide proof of purchase or other documentation, the amount is permanently withdrawn and the merchant is charged a “chargeback” fee.

Merchant Statement

A merchant statement is a monthly report of your total sales volume, average ticket size, transactions, and processing fees. The merchant statement is prepared by the merchant processor according to the agreed-upon rates.

Merchant Processing Fees

The credit card processing fee structure is one of the most complex and confusing fee structures in the financial industry. It can be challenging even for those with a lot of experience, especially since fees change from time to time and from processor to processor.

To help you understand it better, here’s a quick breakdown of the different fees you will pay for merchant processing.

Interchange Rates

Interchange rates are the rates charged by the major credit card associations (Visa, MasterCard, American Express, and Discover) to process your customers’ credit or debit card transactions. These are expressed as a percentage of the transaction plus a small transaction fee.

For example: an item costs $50. The interchange rate for that particular transaction is 1.8% + $0.20. You would have to pay $1.10 in fees to cover the processing of that transaction.

There are hundreds of different interchange rates that are decided by your business type, whether it was a card-present or card-not-present transaction, and other factors. Your interchange rates aren’t always quoted on your merchant statement, especially if your processor charges you a flat rate or bundled pricing.

Interchange fees are non-negotiable and make up the bulk of your merchant processing fees. No matter which processor you sign up with, the interchange rates will remain the same. These rates change throughout the year and are regularly updated on your card network’s websites.


As all interchange rates are the same across the board no matter what processor you work with, the markup is the main differentiator between processors’ rates. The markup is basically the difference between the interchange rate and the rate you are actually charged. This is where the processor makes its profit.

For example: the interchange fee for a particular transaction is 1.8% + $0.20. The merchant discount, or the rate you are actually charged, is 2.3% + $0.30. The merchant’s markup would then be an additional 0.5% + $0.10 per that transaction type.

Merchant Processing & Transaction Fees

These include assessment fees also charged by the card network, as well as additional fees from the processor. These fees can be charged on a monthly or per incident basis. Examples of common processing and transaction fees include: authorization fees, monthly minimum fees, batch processing fees, chargeback fees, statement fees, membership fees, compliance fees, setup fees, and cancellation fees.

Merchant Processing Pricing Models

Merchant processors are the same in the sense that they will all charge you a combination of interchange rates, assessments, markups, and other. However, they differ in how they charge you those rates and fees.

There are three main kinds of pricing models that you will encounter when shopping around for a merchant acquirer: interchange plus, tiered, and flat pricing. We describe the differences below. 

Interchange Plus Pricing

Even though it can come off as complicated first, the key to understanding interchange plus pricing is in the name. Merchant processors will charge you the interchange rates plus their markup. Because the interchange rate is quoted separately from the markup, you can easily see how much you’re paying on top of the non-negotiable fees.

The benefit of interchange plus pricing is that it is the most transparent and usually cheapest of the different pricing models. It might be more difficult to understand at first (especially because there are over 300 different interchange rates), but it gives you more knowledge and control over your fees.

Tiered Pricing

Tiered pricing is the next most common merchant processing pricing model. Also known as bundled or bucket pricing, tiered pricing groups the hundreds of interchange rates into three or four main categories. All transactions in a single category will have the same flat fee, even though they have different interchange rates.

The merchant processor divides the transactions into tiers using a “qualification matrix”. The qualification matrix takes into consideration the card type, risk of the transaction, transaction amount, and other factors. While tiered pricing can have any number of categories, the most common one is the three-tiered model. Rates are categorized as (from lowest to highest rates): qualified, mid-qualified, and non-qualified.

The benefit of tiered pricing is that it is significantly less complicated to understand. You only have to read a handful of rates instead of literally hundreds of them. However, the downside is that it’s not a transparent pricing model. You won’t know what the markup is, much less if it’s a fair markup.

Plus, merchant processors who provide tiered pricing usually aren’t transparent about how they categorize your transactions. Even if they hook you in with “low” rates for the most qualified category, most of your transactions could be funneled into the tier with the highest rates without your knowledge.

Flat Rate

Flat rate pricing is the simplest model out of the three. This pricing model charges you a single flat fee for
all transactions, regardless of the type. So instead of hundreds of rates under interchange or 3-4 rates under tiered pricing, you only have one fee. Think of payment processors like PayPal, Stripe, or Square.

The benefit is, of course, its simplicity. Because you have one flat fee, you can easily project your expected fees even before your monthly statement arrives. However, the flat rate pricing model is also notoriously the least transparent and, overall, the most expensive for most businesses.

If you’re still not sure how to read or evaluate your credit card processing statement, we’ve made a guide specifically for those trying to understand their merchant statement. We guarantee it’s everything you’ll need to know.

If you’re not satisfied after that, we’d be happy to take a look – for free.


Now that you understand the basics of merchant processing, you are much better equipped to choose the right merchant acquirer for your business. When picking a merchant processing service, keep in mind the following tips:

  • Don’t look at the rates offered to you, look at the markup.
  • Get quotes from different merchant processors so you can compare the fees.
  • Negotiate, negotiate, negotiate. You may be able to get your rates down without having to switch to a different provider.
  • When in doubt, stick to interchange plus pricing. It’s the most transparent and more often than not has the lowest fees.
Article Summary
Article Name
Merchant Processing Explained for Frustrated or Confused Merchants
A simple and thorough guide to merchant processing. The guide is for merchants looking to understand credit card processing.
Publisher Name
First Payment Services
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