What is a payment processor and how do they work?

Payment processor services act as liaisons between businesses, credit card companies and banks. They transfer data between these entities to allow merchants to accept card payments from customers in-person and online. Without a payment processor, businesses would have no way of verifying, authorizing and receiving credit and debit card payments from customers. 

Many of today’s card processors also give customers and merchants even more ways to pay and get paid. For example, many accommodate digital wallet payments, ACH payments, eChecks, automatic debiting for recurring payments, along with popular international payment methods that are especially helpful for e-commerce businesses looking to expand their global customer base. 

Featured credit card processing offers

Stax

Learn More

Via Stax’s website

Monthly fee

$99

Swiped transaction fee

7¢ to 10¢ + interchange rate

Merchant One

Learn More

Via Merchant One’s website

Monthly fee

$13.95

Swiped transaction fee

0.29% to 1.55% per transaction

Payment Depot

Learn More

Via Payment Depot’s webiste

Free Trial

No

Offers

$0 Setup & No Cancellation Fees

Pricing

Customized Interchange+ Pricing – Rates as low as 0.2% – 1.95%

Clover

Learn More

Via Clover’s website

Monthly fee

$14.95

Swiped transaction fee

2.6% + 10¢

What is a payment processor and what do they do?

Simply put, payment processors make card payments possible for both merchants and customers. They transfer funds and verification data between the merchant, credit card network and issuing and acquiring banks to authenticate, authorize and process transactions from sales made using a credit or debit card. So, whether you’re running a brick-and-mortar store or opening your first e-commerce store, you’re going to need one.

For example, when a merchant accepts an in-person credit card payment, the payment processor verifies the authenticity of the transaction and then transfers the card data from the point of service (POS) to any banks involved so that the merchant can get paid. Through the verification and authorization process, the payment processor takes steps to detect fraud or insufficient funding. If it deems that the customer cannot pay or there is fraud present, it will also decline the transaction. 

Basic payment processor vocabulary 

Here are some common terms you’ll come across in the world of credit card processing.

BASIC PAYMENT PROCESSOR VOCABULARY
Cardholder	The person or company that owns the credit or debit card being used to pay for a product or service. Cardholders must abide by the terms and conditions of the card they are using when making card purchases
Merchant	A business owner who provides goods and services to customers in exchange for payments made by cash, credit cards, debit cards, ACH, eChecks and digital wallets
Acquirer or acquiring bank	The bank used by the merchant to accept payments from customers. Most small businesses use credit card processors to make deposits into merchant bank accounts on their behalf
Issuer or issuing bank	The financial institution that issues credit cards to consumers and businesses. These banks are in charge of setting credit card interest rates, credit limits and any associated fees. Payment processors request funds from these banks to pay merchants when a customer uses a credit or debit card. The issuer can either approve or decline such requests based on whether the funds are available to the customer for use on the sale
Payment gateway	The technology that verifies credit or debit card information primarily during an online sale process, after which the sale data is securely transferred to the credit card processor for further steps in finalizing the sale
Credit card processors	A credit card processor collects payment information, secures such information and submits payment details to issuing banks. As it does, it checks for fraud and sufficient funds to cover the sale. It then requests funds from the issuing bank and transfers it to the acquiring (merchant’s) bank
Payment networks	These companies offer cards that enable electronic fund transfers from the issuing bank to the acquiring bank so consumers can purchase products online or in-store. Four major payment networks are American Express, Discover, Visa and Mastercard
PCI compliance	Payment card industry (PCI) compliance is a set of standards that all businesses must comply with when storing, processing and transmitting credit or debit card information. These guidelines work to secure sensitive customer information and regulate the way businesses can accept, transmit and store such data. Ultimately, they serve to prevent fraud and data breaches
Swiped payments	Payments made at a merchant’s physical location at the point of sale (POS) using a card reader. Customers swipe their card’s magnetic stripe into the payment hardware, which then collects, transmits and approves (or denies) the in-person payment
Keyed-in payments	If there’s no way to swipe a credit card, or if the magnetic stripe isn’t working, merchants can also key in payment data — such as card numbers — manually through their payment processing hardware. The ability to key in payments is especially useful for merchants who take payments over the phone
EMV	An acronym for Europay, Mastercard and Visa, EMV is the technology standard that oversees the tiny-yet-powerful chips that come in most credit and debit cards today. EMV chips work to provide more safe and secure POS transactions than their magnetic predecessors. Their primary purpose is to curb credit card fraud. They offer data encryption and they cannot be counterfeited like magstripe technology can. If a customer uses an EMV card and the transaction is fraudulent, the liability falls on the bank, not the merchant
Digital wallet	Electronic applications that give customers the ability to store money and conduct transactions by using their preferred digital devices such as a mobile phone or smart watch. Digital wallets are especially useful for consumers who don’t want to carry around and keep track of multiple credit and/or debit cards. PayPal, Venmo, Apple Pay, Samsung Pay, Google Wallet and Cash App are all examples of popular digital wallets
eChecks	Digital versions of paper checks that are used in automated clearing house (ACH) payments. Payment processors use the ACH system to process eChecks, thereby debiting the checking account of the person paying with an eCheck and crediting the merchant’s bank account
Merchant-designated bank account	These are third-party bank accounts that enable businesses to make and accept various forms of payment by holding such payments in the merchant account before depositing them into the business bank account (typically one to two days later). Merchant-designed bank accounts are the intermediary accounts between credit card companies, the consumers who use cards to pay and the businesses that accept credit card payments
Point of sale (POS) system	The platform customers use to pay for a product or service. POS systems come in physical and digital forms, allowing for in-person or online transactions to take place

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How do payment processors work?

Without a payment processor in place, your business would have no way of accepting credit and debit card payments from your customers. Payment processors work by acting as the backend intermediary between customers, businesses and payment networks (such as Visa or Mastercard). As such, they manage a secure card transaction process and handle the communication and fund transfers between your customer’s card and your bank account where payments for sales are deposited.

Here is how payment processing works:

1. The customer pays with their preferred payment method

Customers may pay at your brick-and-mortar store using a magnetic stripe card or a card with an EMV chip. They would swipe or insert the card into your store’s payment processing hardware. 

Digital wallets are also popular among consumers, making online, in-app and even in-store purchases a breeze as customers use their preferred digital devices such as a smartphone, tablet or smartwatch to tap and pay. 

For phone-ins, merchants collect the card number, expiration date and the card verification value (CVV). This is a four-digit number on American Express cards, and three digits for Visa, MasterCard and Discover. The CVV proves customers have the physical card in hand.

2. Data is sent to your payment processor

A payment gateway gathers card information and the purchase amount, then transmits it to the credit card processing service. Many payment processing companies include the payment gateway as a part of their service features. 

3. Card data is routed through the credit card processor 

Once the payment processor receives the card data, the processor takes this data and validates it. It then routes the data to the appropriate payment network, such as American Express or MasterCard, for approval. 

4. Authorization is requested by the payment network

The issuing bank (the financial institution that issued the credit card to the cardholder) receives the authorization request and checks for suspicious or fraudulent activity and availability of funds before determining whether to approve or deny the request. Once the decision is made, the payment processor is notified of the payment’s approval or denial. 

5. The transaction is approved or denied

If the transaction is approved, the payment processor is notified. The payment processor notifies the gateway, which then notifies the business and customer of the transaction’s approval or denial. 

6. The merchant completes the sale

If the transaction is approved, the merchant will print a receipt or deliver it electronically to the customer, and then save the transaction record in the payment processing software for accounting purposes. Funds from the customer’s account are transferred to the processor’s bank and the merchant closes the payment process out. 

7. Funds are delivered to the merchant account

Usually once a day, a batch of these transactions is sent from the business to the payment processor for settlement. The customer payment is then delivered from the issuing bank to the merchant’s bank account by way of the card processor’s bank, less processing fees. This typically takes place over one to two business days. 

Who are the top payment processors in the US?

We’ve reviewed dozens of credit card processing companies to help you choose the best fit for your needs. In the end, our top picks included Square, Stripe, Paypal and Helcim. Read our best credit card processing companies list for guidance on how to choose the best fit for your company needs.

Credit card processors that sit at the top of the list offer online and in-person transaction rates of 3.5% and below, provide free or reasonably priced credit card processing equipment for storefronts and mobile merchants and offer excellent customer service and troubleshooting for small businesses getting their new systems up and running. 

The best credit card payment processors give merchants the ability to accept payments in as many ways as possible. This rings especially true for e-commerce merchants who have the potential to gain customers worldwide.

Top payment processors also won’t try to hide the cost of their services and will provide transparent pricing for every fee when possible. This may include monthly fees, transaction fees (that may vary depending on whether such transactions are swiped/chipped entries, online or keyed-in entries) and any chargeback fees that may apply. 

Payment processor vs. payment gateway

The terms payment processor and payment gateway are often used interchangeably, but in fact, these two services are not one in the same. 

Payment gateways are responsible for verifying that a customer’s credit card information is correct before sending that information to the payment processor. The payment processor then works as the intermediary between the credit card company, the banks and the merchant to ensure that the funds are transferred correctly and the business gets paid for its products or services in a timely way. 

It can be easy to confuse payment processors and payment gateways. The below table illustrates key factors that set these two credit card processing services apart.

PAYMENT PROCESSOR	PAYMENT GATEWAY
Acts as an intermediary between the acquiring bank, issuing bank and merchant to transfer funds after a sale is paid using a credit or debit card. In this process, it also communicates the transaction’s approval or denial to involved businesses and customers	Gathers, verifies and encrypts credit card information usually of online customers; however, it can be used for this purpose to accept payments using a credit card reader, POS system or payment software. It then transfers the data to the payment processor for logistical support in completing the transaction
Ensures credit card validity through in-person point-of-sale (POS) transactions	Ensures credit card validity primarily for online sales
A stand-alone service that can be used without a payment gateway	Is not a stand-alone service and must be used with a payment processor
Best for in-person transactions and brick-and-mortar stores	Best for online stores and e-commerce brands

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Choosing a payment processor for your business

Choosing the best credit card payment processor for your business means taking into account where you meet your best customers (and where they find you), as well as your typical point of sale (POS). After all, an online e-commerce store has very different needs than a chain of 24/7 diners. 

To evaluate the right payment processor for you, you’ll need to consider the current size of your business, how many monthly transactions you expect to process, how much you expect to scale and grow your business, what payment types your best customers prefer to use and your industry-specific needs. 

Before choosing a payment processor for your brand, consider the following:

Your estimated transaction volume 

For small businesses, startups with low sales volume and seasonal businesses, choosing a volume-discounted payment processor makes little sense. Instead, look for a payment processing service that offers a low (or no) monthly fee.

Your equipment requirements

If you’re operating a strictly e-commerce business, there’s a good chance you don’t need point-of-sale (POS) equipment or terminals to accept in-person payments, but you’ll likely need a gateway. On the flip side, physical storefronts such as restaurants and retail stores need payment processing hardware so that they can accept swiped, chipped and keyed-in payments from in-person customers. 

So, if your business requires credit card processing hardware, pay special attention to payment processing services that are transparent about equipment pricing and offer a wide selection of hardware options. If you run an e-commerce store, look for a payment processor that offers a gateway.

Your customer’s most-used payment types

Different payment processors accept different forms of payments. While all accept debit and credit cards, not all accept digital wallets. And, even among those that do accept digital wallets, many only accept a select type of digital payments, such as Apple Pay but not cryptocurrency. Survey the types of payment methods your customers prefer to use and find a payment processor that allows you to accept such payment methods.

Your industry

Some credit card processing companies do not work with certain industry types — think gambling, high-risk or collections businesses or any business within an industry that may experience a regular onslaught of customer disputes. Conversely, some payment processing services prefer to work with specific industries and will offer better rates on transactions for their preferred partners. They may even offer specialized equipment or capabilities, such as the ability to easily accept and process tips. So, make sure to inquire about industry-specific promotions, equipment and rates before signing on with a payment processor. 

Featured credit card processing offers

Stax

Learn More

Via Stax’s website

Monthly fee

$99

Swiped transaction fee

7¢ to 10¢ + interchange rate

Merchant One

Learn More

Via Merchant One’s website

Monthly fee

$13.95

Swiped transaction fee

0.29% to 1.55% per transaction

Payment Depot

Learn More

Via Payment Depot’s webiste

Free Trial

No

Offers

$0 Setup & No Cancellation Fees

Pricing

Customized Interchange+ Pricing – Rates as low as 0.2% – 1.95%

Clover

Learn More

Via Clover’s website

Monthly fee

$14.95

Swiped transaction fee

2.6% + 10¢

Frequently asked questions (FAQs)