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Most customers expect you to accept debit and credit card payments. To do so, you need a merchant account. Here’s what to expect when you're opening a merchant account for your business.
To accept debit and credit cards, businesses commonly use a merchant account. A merchant account is a designated account for the payment processor to send your transaction funds until they’re settled. You do not have access to the funds in your merchant account. After the transaction is settled, the funds are transferred to your separate business bank account.
This guide explains how merchant accounts work, how to set one up, and what you need to know about merchant accounts as a small business owner.
A merchant account is a special business bank account, often provided by the payment processor, that is required for businesses to accept debit and credit cards, as well as other forms of electronic payment. A merchant account acts as a bridge between a customer’s credit account and a business checking account. During a transaction, funds are immediately deposited into a business merchant account. They are then deposited into a business checking account upon settlement, usually in one to two days.
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Once you have a merchant account and payment processing company for your business, you can begin conducting credit card and debit card transactions with your customers. Because it’s a business bank account, you need a business license to set up a merchant account.
To begin processing debit and credit card payments, you usually also need hardware, which is available for purchase through your credit card processing partner. In some cases, payment processors even provide free credit card readers to help users get started.
When a customer pays with a card or orders something on your website, you need a way to accept the card and send the information to your payment processor. This is called the payment gateway. The type of gateway you need depends on how you expect to receive payment.
Key takeaway: Confused by credit card processing terms? Here’s a primer:
Your merchant account may fit into one or more of these categories:
The payment processor does the work of processing your customers’ transactions. The merchant account is where the payment processor temporarily deposits money from the sale until settlement.
Payment processors often provide merchant accounts, but you can also get a merchant account at your bank or another financial institution.
Acquiring a merchant account is relatively straightforward. Follow these steps to create an account.
The first step in obtaining a merchant account is research. Fees and limitations vary, and you should determine which companies offer the best solution for your business.
If you have friends in a similar field, consider asking them for recommendations. You can also compare merchant accounts online. Your bank may offer merchant accounts, which may be advantageous. Your bank may be more likely than others to approve your business for a merchant account, especially if your company is new.
When you apply, your prospective merchant account bank should provide clear answers about the type of documentation required and how long the approval process should take.
Be ready to provide the following business information:
Once you submit the requested information, the financial institution will likely check your personal and business credit history. Depending on the institution, you may need to pay an application fee.
Add a cover letter to your application to explain precisely what your business does and why it deserves a merchant account.
The merchant account provider will evaluate your application and decide whether to approve your account. The merchant account provider will consider these factors:
Your business is considered less risky if you plan to process customers’ transactions in person. Processing cards online or by phone is considered riskier because these transactions are more vulnerable to fraud. To mitigate this risk, some merchant account providers require address verification when cards aren’t present.
The merchant account provider will likely approve your application if your business history and transaction type make you a low-risk option. Riskier companies may still be approved, but they’ll likely have additional and higher fees.
Here’s what happens when a credit card transaction is processed.
The payment gateway checks whether the cardholder has sufficient funds for the transaction. If your business accepts card payments over the phone or through an online portal, the business requires a payment gateway. A keyed-in or card-not-present transaction is done online through a payment gateway that connects to the credit card company.
Your credit card processor can set up a payment gateway for you at the same time your merchant account is established. However, payment gateways generally incur an additional monthly fee, and card-not-present transactions usually have higher costs than card-present transactions.
If the transaction is approved, the processor deducts the purchase amount from the customer’s bank account or credit card account. First, it deducts the transaction fee, which is usually 3% to 5% of the total. The fees vary depending on the payment type. For example, transaction fees are usually higher for American Express than for Visa or Mastercard. The processor deposits the money into your merchant account, where it is not available to you yet.
At settlement, the merchant account deposits the money into your business checking account. These deposits usually occur in batches at the end of the day, or even less frequently, rather than right after each transaction.
If there is a customer dispute, the merchant account must pull the transaction information to verify it. There is often a fee for this. If you agree that a refund, or “charge-back,” is warranted, the merchant account provider withdraws funds from your account and deposits the money into the customer’s account. If you dispute the charge-back, the case goes through a resolution process, which may result in dismissal of the customer’s dispute or withdrawal of the refund amount from your account.
The fees associated with a merchant account vary by provider. Card-present transactions are generally considered the least susceptible to fraud, so the rates for those transactions are often the lowest.
In some cases, merchant accounts adhere to a fixed per-transaction rate without additional fees. Others use an interchange-plus pricing model, which is the credit card company’s processing fee plus the merchant account provider’s markup. Finally, the tiered pricing model offers different rates depending on the type of transaction.
Here’s a closer look at each model:
These are some additional fees beyond the pricing models:
Some fees are unavoidable, but not all of them are common across credit card processors. Do your due diligence to make sure you are not surprised by high fees.
It’s possible to accept credit cards without your own merchant account by using a payment aggregator. Payment aggregators have one master merchant account, and each individual merchant is a sub-merchant on the account. These alternatives often work well for small businesses and startups.
Want to compare PayPal and Square side by side? Check out our comparison page to see how the two stack up.
In today’s world, most customers expect to pay with a credit or debit card; many customers don’t even carry cash. Failing to accept these payment methods could upset your customers and hurt your bottom line.
To accept your customers’ debit and credit cards, you need a merchant account or a payment processor that uses aggregate merchant accounts. You also need a payment processor and in-person or online payment gateways. It’s important to understand how all the parts of the credit card acceptance system work so you can choose the best system for your business.
Sally Herigstad contributed to this article.