The ABCs of Merchant Services: Terms You Need to Know

If you run a business that accepts credit card payments, whether in person or online, you’re likely already familiar with the concept of merchant services. However, the payment processing industry is filled with jargon that can confuse newcomers. This article breaks down the ABCs of merchant services, providing an easy-to-understand glossary of the top terms you need to know.

Acquiring Bank

The acquiring bank, also known as the merchant bank, is the financial institution that maintains your merchant account. This bank receives payments made by your customers with their credit or debit cards.

Address Verification Service (AVS)

Address verification service (AVS) is a fraud prevention tool used by businesses to verify that the customer’s billing address matches the address on file with their credit card company. If there is a mismatch, the transaction may be declined due to potential fraud risk.

Authorization

An authorization is an approval from the credit card issuer that the customer has sufficient credit available to cover the cost of the transaction.

Batch Processing

Batch processing refers to the accumulation of credit card transactions over a specified period (usually a day), which are then sent as a group (or batch) for settlement.

Card Brands

The major card brands are Visa, Mastercard, American Express and Discover. These are the networks that facilitate the transfer of payment information during a credit or debit card transaction. Each card brand has its own unique rules, regulations and fees that merchants must abide by.

Capture

Capture is the process of finalizing a transaction that has been authorized but not yet settled. The capture process sends the transaction for settlement and is when the customer’s card is actually charged.

Card Not Present (CNP) Transactions

Card not present transactions are transactions where the cardholder does not physically present the card for a merchant’s visual examination at the time that an order is given and payment effected. These are typically online, mail order, or telephone order transactions.

Card Present Transactions

Card present transactions are transactions where the merchant is able to physically examine the card at the point of sale.

Card Verification Value (CVV)

The card verification value (CVV) is a three or four-digit code found on the back of credit and debit cards. This code is used to verify that the person using the card has physical possession of it, adding an extra layer of security against fraud.

Chargeback

A chargeback occurs when a customer disputes a charge from your business with their card issuer. If the dispute is ruled in the customer’s favor, the transaction amount is returned to the customer, often with an additional fee charged to the merchant.

Descriptor

The descriptor is the name that shows up on a customer’s credit or debit card statement after a purchase is made from your business. The descriptor identifies the merchant for the cardholder. Proper descriptor formatting ensures charges are recognizable by customers and reflect positively on your brand.

Discount Rate

The discount rate is the percentage of each transaction that the merchant pays to the acquiring bank for processing the transaction. This fee usually ranges from 1% to 3%.

Downgrade

A downgrade occurs when a transaction fails to qualify for the original interchange rate and gets bumped to a higher cost tier. This usually applies for tiered pricing models.

Early Termination Fees

Cancelling a merchant services contract before the term is up often incurs hefty early termination fees.

Ecommerce

Ecommerce (short for “electronic commerce”) is the buying and selling of goods or services using the internet, and the transfer of money and data to execute these transactions. They typically involve a shopping cart and online checkout experience.

EMV

EMV stands for Europay, Mastercard and Visa. EMV chips are computer chips embedded in credit and debit cards that provide enhanced security features. EMV chip cards create a unique transaction code that cannot be reused. Accepting EMV chip payments typically requires upgraded point-of-sale (POS) systems with integrated EMV chip card readers.

Encryption

Encryption is a security measure that transforms sensitive information into a code to prevent unauthorized access. In the context of payment processing, data is encrypted to protect cardholder information during a transaction.

Fallback Transaction

A fallback transaction occurs when an EMV chip card is processed as a traditional magstripe card transaction instead of dipping or tapping the chip. This may happen when the payment terminal does not have chip card capabilities. While still secure, fallback transactions do not carry the added layer of EMV security.

Flat-Rate Pricing

With a flat rate pricing model, all transactions are charged the same pre-determined rate regardless of card type.

Fraud Prevention

Fraud prevention encompasses a variety of strategies and technologies designed to prevent fraudulent transactions. Common tools include Address Verification Service (AVS) and Card Verification Value (CVV) checks.

Gateway

A payment gateway is the technology that captures and transfers payment data from the customer to the acquirer and then transfers the payment acceptance or decline back to the customer.

High-Risk Merchant Account

High-risk merchant accounts are accounts provided by acquiring banks for businesses that are considered high risk due to various factors such as high transaction volume, potential for chargebacks, or the nature of the business itself. High-risk merchant accounts often come with higher transaction fees.

Holdback

A holdback, or reserve, is a portion of the revenue from a merchant’s credit card transactions, held by the acquiring bank as a kind of insurance against future chargebacks and other risks.

Hosted Payment Page

A hosted payment page is a secure web page provided by a merchant services provider to collect customer payment details. This allows online payments to be safely collected without the payment data having to pass through the merchant’s website. Hosted payment pages help increase compliance with PCI security standards.

Interchange Fees

Interchange fees are transaction fees that the merchant’s bank account must pay whenever a customer uses a credit/debit card to make a purchase. They are set by the credit card networks (Visa, MasterCard, etc.) and vary based on factors like card type and transaction method.

Issuing Bank

An issuing bank is a bank that offers card association branded payment cards directly to consumers. The issuing bank is also responsible for the customer’s balance and managing their account.

JCB

JCB is a credit card company based in Japan. Accepting JCB cards can be important for businesses that attract a large number of customers from Japan or other parts of Asia.

Keyed-In Transactions

Keyed-in transactions are those where the cardholder’s information is manually entered into a payment terminal, rather than swiped or inserted. These transactions often have higher processing fees due to the risk of fraud.

Leased Equipment

Many merchant services providers offer the necessary payment processing equipment like credit card terminals and POS systems on a leased basis. This saves upfront costs for the equipment. However, monthly leasing fees continue for the duration of the merchant services contract until equipment is returned or bought out.

Level 2 and Level 3 Processing

Level 2 and Level 3 processing refers to additional information provided in a credit card transaction, often used by businesses and government agencies. Including this information can result in lower interchange fees.

Magnetic Stripe (Magstripe)

The magnetic stripe (magstripe) is the black or brown strip on the back of a credit card, debit card, or gift card. This stripe contains customer and account information that’s required to complete a transaction.

Merchant Account

A merchant account is a type of bank account that allows businesses to accept payments via debit or credit cards. This account holds funds from card sales before they are transferred to a regular business bank account. You can’t process card or online payments without one.

Merchant Category Code (MCC)

A merchant category code (MCC) is a four-digit number assigned to a business by the credit card companies (Visa, MasterCard, etc.) when the business first starts accepting one of these cards as a form of payment. The MCC is used to classify the business by the type of goods or services it provides.

Merchant ID

The merchant ID is a unique number assigned to identify each business account. It allows sales to be properly credited to the merchant. The merchant ID must be linked with any payment terminals and integrated POS systems. Be sure this number transfers correctly when changing merchant accounts.

Merchant Services Provider

Merchant services providers (also known as MSPs) help businesses set up a merchant account and start processing payments. They handle all of the moving pieces behind the scenes to simplify payment processing for their customers.

Mobile Payments

Mobile payments refer to payment services performed from or via a mobile device. This could include payments made through mobile apps, mobile wallets, or contactless payments using NFC technology.

Network Fees

Network fees are charges that payment networks (like Visa or MasterCard) assess on each transaction. These fees are in addition to interchange fees.

Non-Compliance Fee

Failure to maintain PCI compliance can result in fines in the form of non-compliance fees.

Non-Qualified Transactions

Not all transactions are created equal when it comes to processing fees. Debit/credit transactions that fail to meet card network requirements are deemed “non-qualified.” These are charged higher interchange fees. Ensuring cards are present, using EMV chip processing, and obtaining signatures and billing zip codes help minimize non-qualified transactions.

Overdraft

An overdraft occurs when money is withdrawn from a bank account and the available balance goes below zero. In the context of a merchant account, this could occur if there are insufficient funds to cover chargebacks or fees.

Payment Card Industry Data Security Standard (PCI DSS)

The Payment Card Industry Data Security Standard (PCI DSS) is a set of security standards designed to ensure that all companies that accept, process, store or transmit credit card information maintain a secure environment.

Payment Gateway Reconciliation

Payment Gateway Reconciliation is the process of comparing the records of transactions processed by the payment gateway with the records of transactions in the merchant’s bank account to ensure that the numbers match.

Payment Processor

A payment processor is a company (often a third party) appointed by a merchant to handle transactions from various channels such as credit cards and debit cards for merchant acquiring banks. Essentially, they facilitate payment processing.

PCI Compliance

PCI stands for Payment Card Industry, and the PCI Data Security Standard refers to a set of comprehensive security requirements merchants must abide by to accept payments securely and reduce fraud. This includes physical, network, and policy safeguards. Performing quarterly scans and proper staff training helps maintain PCI compliance.

Point of Sale (POS)

The point of sale (POS) is the place where a customer executes the payment for goods or services and where sales taxes may become payable. A POS transaction may occur in person or online, with receipts generated electronically or physically.

Point-to-Point Encryption (P2PE)

Point-to-Point Encryption (P2PE) is a standard established by the PCI Security Standards Council. P2PE solutions secure cardholder data from the point of interaction (when the merchant accepts the payment card) until the data reaches the solution provider’s secure decryption environment.

Processing Fees

Processing fees refer to all the costs charged by a merchant services provider to handle credit and debit transactions. This includes interchange fees, assessment fees, monthly service or rental fees, statement fees, etc. Understanding the fee structure is vital when comparing merchant services providers.

Qualified Rate

The qualified rate is the lowest rate a merchant will be charged whenever they accept a regular consumer credit card and process it in a manner defined as “standard” by their merchant account provider. This often means swiping the card through the card reader on a physical terminal.

Quantitative Analysis

Merchant service providers use quantitative analysis and statistical modeling to assess potential risk and exposure associated with merchants. Factors like processing volume, average ticket size, and length of time in business are all considered. High-risk merchant accounts face increased fees and transaction limits.

Rate

The rate refers to the transaction fee percentage that the merchant services provider charges per sale on top of interchange fees. Qualified, mid-qualified, and non-qualified transactions may have different rates. Payment processing costs are typically calculated using your rate and monthly volume.

Refund

A refund is a reversal of a payment from the merchant back to the customer, typically due to the customer returning goods, or being dissatisfied with services provided.

Retrieval Request

A retrieval request is when the card issuer requests documentation about a specific transaction from the merchant through the acquiring bank.

Rolling Reserve

A rolling reserve is a type of cash reserve where a portion of the merchant’s sales are kept by the payment processor for a specified period. It’s a risk management strategy to cover potential chargebacks or fraud.

Settlement

Settlement is the process by which card transactions are batched and submitted to the merchant’s acquiring bank for payment. It typically occurs at the end of each business day.

Set Up Fees

Setup fees are one-time charges assessed when establishing a new merchant account. This may cover costs for initiating the account, underwriting approval, payment terminals or POS system installation, software integration, etc. Setup fees can sometimes be negotiated or waived.

Split Funding

Split funding is a payment processing arrangement, often used by businesses like salons or spas, where payment for a single transaction can be divided and deposited into multiple accounts. This might be used, for instance, to split funds between a business and an independent contractor working at that business.

Tiered Pricing

A tiered pricing model charges different rates for qualified, mid-qualified, and non-qualified transactions based on interchange categories.

Terminal

A credit card terminal is the hardware that reads customer credit and debit cards and submits transaction information. Terminals may be countertop or handheld, operate via phone lines or WiFi, and permit EMV chip cards and contactless payments like Apple Pay. Integrated POS systems make terminals seamless.

Tokenization

Tokenization is a method of protecting sensitive data by replacing it with an algorithmically generated number, or “token.” In terms of credit card transactions, tokenization can be used to securely store card data, reducing the merchant’s risk of data breach.

Underwriting

Underwriting is the process by which banks and payment processors evaluate the risk of taking on a new merchant. This process includes reviewing the merchant’s credit history and business model.

Virtual Terminal

A virtual terminal is a web-based system that allows merchants to process credit card transactions manually. Merchants can enter card details received over the phone or by mail into the virtual terminal to process the payment.

Voice Authorization

Voice Authorization is a security measure used for credit card transactions where the merchant calls an automated system to authorize the payment. It’s typically used when the card cannot be physically swiped or processed through an online payment gateway.

Wireless Processing

Wireless or mobile processing refers to the use of wireless devices (like smartphones or tablets) to process credit card transactions. This can be particularly useful for businesses that operate on the go.

XML Messaging

XML (Extensible Markup Language) messaging is a method of encoding transactions as XML documents. It’s often used in e-commerce and mobile payment gateways to ensure the secure transmission of transaction data.

Yearly Volume

Yearly volume refers to the total amount of credit card sales a business processes in a year. This figure can affect the rates and fees a merchant pays for their merchant account.

Yield

In merchant services, yield refers to the revenue earned from merchant accounts after covering the costs of interchange fees, assessments, and services. Maximizing yield is a priority, which is achieved by adding value for clients that command higher processing rates. High-risk industries have lower yields.

Zero Cost Processing

Also called surcharging, zero cost processing means credit card fees are passed along to the customer if they choose to pay with a credit card rather than a debit card. With this pricing structure, the merchant is still responsible for paying debit card fees but will typically have no credit card processing costs.

Zero Liability

Major credit card brands offer zero liability policies to protect consumers against unauthorized or fraudulent charges. Merchants are liable for chargebacks resulting from disputed transactions. However, when businesses comply with card network rules and security standards, zero liability applies on the merchant side as well for fraud losses.

Zero Floor Limit

Zero floor limit means that every transaction a merchant makes must be authorized by the cardholder’s bank. It’s a fraud prevention measure that ensures the cardholder has sufficient credit or funds to cover the transaction.

Final Thoughts

This ABC of merchant services should help demystify the jargon that you may come across in the payment industry. While this glossary is extensive, it’s by no means exhaustive. If you come across a term you don’t understand, don’t hesitate to ask your payment processor or do some research. Understanding the language of payment processing can help you make the best decisions for your business and help you save money in the long run.