A customer paying with a credit card at a register.

The difference between credit and debit card payment processing

Sunday, November 30, 2014
In the modern age, it’s almost a necessity for every business to be able to accept credit and debit card payments. This entails working with a payment processor, who asks as a mediator between merchants and customers.

  • For businesses, payment processors ensure accurate transactions and timely transfer of funds between the customer and merchant.
  • For customers, payment processors establish encrypted payment gateways in order to secure customer bank information that’s transmitted with every purchase.
  • In the event of fraudulent transactions, payment processors will work with both parties to resolve the situation ("What to do if you suspect credit card fraud by a customer").

For customers, the difference between debit and credit cards is straightforward: debit cards withdraw funds from the bank account attached to it to make purchases, while credit cards create a balance in one’s bank account that is paid off monthly.

For merchants, however, the differences between processing credit cards and debit card payments are not only more complex, but also lesser known and understood. Because businesses will be running a multitude of these transactions everyday, this article will focus on detailing these differences so you can be aware and informed about how these payments affect your business.

Comparing debit vs credit transactions

How credit card transactions work for merchants: When a customer uses a credit card, they’re essentially taking out a loan from the bank who issued their card. The process looks like this:

  • a customer makes a charge with their credit card
  • the charge information is transmitted into the card network and then sent to the acquiring bank, which in turn requests payment for the charge from the issuing bank
  • the issuing bank checks the customers available credit and whether or not the transaction is suspicious; if all checks out, the issuing bank authorizes the payment
  • the merchant is then paid by the acquiring bank
  • the customer now owes money to their issuing bank, which they’ll pay off periodically

The acquiring bank is the merchant’s chosen financial entity to process card transactions, and works as the mediator between a customer and a merchant. In most cases, the acquiring bank is a merchant’s very own payment processor and the two terms are used interchangeably. However, this isn’t always the case; some payment processors don’t provide this service, and instead work in tandem with an acquiring bank provider (such as the merchant’s actual bank).

Fees regarding credit card transactions: Acquiring banks perform a handful of duties when they mediate credit card transactions, and in turn charge fees to merchants for doing so. Throughout the entire transactional process, acquiring banks are dealing with sensitive information that they have to follow strict security guidelines to keep secure. They must also deal with potential financial risk due to the very nature of dealing with credit cards. Whether your acquiring bank is your payment processor, an actual bank, or a different financial entity performing the role, they’ll be able to talk you through their exact fees and why they charge the amounts they do.

How debit card transactions work for merchants: Unlike credit card transactions, issuing banks don’t have to hold the payment in pending before authorizing the payment. Instead, card holders have pre-authorized their banks to withdraw money from their bank accounts to fund purchases made on the card. Here’s how the process goes:

  • a customer makes a charge on their debit card
  • the merchant's bank requests payment from the issuing bank
  • the issuing bank can simply authorize the payment and withdraw the funds from the card holder’s linked bank account (or, if the funds aren’t available in the account, cancel the transaction instead)

Where debit cards get complicated, is in their ability to have payments processed along two different paths. Before breaking down the fees related to debit cards, let’s break down these two pathways.

Debit charge as “Credit” path: This path has other names that include credit, offline, and the signature debit method. This path occurs when customers hit “credit” on the card reader terminal or if a customer uses a debit card for online transactions. If a merchant lacks a POS system with a PIN pad, then the credit path will be the default.

This method involves the debit transaction information being sent to the same card network that credit card payment information goes to, except in this case it is flagged as a “Debit Transaction”. It goes through the same relay as a credit card transaction except that in the end, after the acquiring bank pays the merchant, the issuing bank simply settles the payment with the acquiring bank with actual funds (rather than credit) from the card holder's bank account.

Like credit card transactions, it may take as long as three days for the acquiring bank to receive the funds from the customer. This is due to the relaying of information required between all the parties, however, the merchant should receive the fronted payment from their payment processor/acquiring bank much sooner than that.

Debit charge as “Debit” path: This path has other names that include debit, online, PIN debit, and “true debit” method. This process typically occurs the most at physical shops where the debit card and cardholder are present and the customer enters “debit” on a card reader terminal or handheld POS system (some chip readers run debit card charges as “debit” as default).

In a true debit transaction, the funds from the purchase are sent directly from the customer's bank to the merchant’s bank. To do this, and avoid the lengthy relay system we’ve described previously, the transaction information is sent on a different network than the card network that credit card payments and “credit” debit charge paths take. This is the same network direct deposits and wire transfers use. This network allows for more direct fund transfers and therefore faster payments, with most transactions being completed within hours or at most by the end of the business day.

Due to the speed of transactions this method allows, and the sensitive bank information necessary to perform them, an encrypted PIN is required to enact them to further secure the correct identity of the card holder.

Fees regarding debit card transaction: Due to debit cards having two ways to process payments, the exact fees merchants pay for debit transactions is fragmented. This is because each method accesses a different network that takes advantage of different security measures and communication speeds, therefore amounting to different costs.

If the method used for a debit transaction is “credit” then the merchant will be charged by its payment processor in the same manner it is for credit cards. Check with your payment processor to learn what exactly your business pays out to them per credit card transaction.

Fees regarding debit card transactions under the “debit” method are more standard. This federal rate is 0.05% of the payment cost per transaction + an additional $0.21. If the purchase meets a certain level of suspicious behavior, then that last addition will be raised to $0.21.

While this rate is the federal standard, it not only can be subject to change, but is negotiable, so make sure to check with your payment processor to settle on a price that fits your company’s needs.

Minimum amounts: Minimum purchase amounts can be enacted towards credit card and credit path debit transactions. True debit card purchases have no minimum limit. This makes sense given the fact that credit card purchases cost merchants more in fees than true debit card purchases. Minimum purchase amounts can help your business:

  • incentive customers to make larger purchases
  • save money in fees by encouraging cash/true debit payments
  • avoid customers breaking down their large orders into single item transactions that can quickly cost you a heavy amount in fees

Surcharges: Another option available to businesses to lessen the costs of card fees is implementing surcharges. Surcharges are additional costs added onto customers' purchases at the merchant’s discretion. However, while surcharging is allowed in the majority of states, it’s not allowed in all of them, so you’ll have to check with your state’s regulations or talk with your payment processor. There are also surcharge regulations that must be followed, and while they can differ between state and card association, they generally operate under these guidelines:

  • 30 day written notice to both your payroll processor and card association before you can implement any surcharges
  • Surcharges aren’t for profit, but rather for covering card processing fees. To ensure this, surcharges have a cap at 4% ( some states 2%) of the transaction amount.
  • Posted signs within your business informing customers of surcharges (or on your website’s checkout page if online store)
  • Surcharges listed out on receipt

Surcharges cannot be implemented on debit card debit path purchases. “True Debit” transactions operate under their own network of regulations and do not allow for surcharges.

Accounts: This doesn’t affect merchants all that much, but the customer accounts linked to credit and debit cards are different.

Credit card accounts have attached credit scores and have differing allowances among individuals based on history of use and monthly payments. For this reason, these accounts are described as “liability” accounts due to the risk and trust involved.

Debit card accounts have almost no barrier of entry aside from age. These work simply as direct storage of funds that are transferred when the card is used.

Disputes: Customers have 120 days to dispute a credit card charge and 60 days to dispute a debit card charge. If they don’t do so in time, paying the charge will have to be fronted on the customers end.

If the credit or debit charge is disputed in time, then merchants will be notified of a chargeback and will have to work through the dispute on their end with help of their payment processor.

Does the difference matter for merchants? Which one should I encourage/accept?

This is an interesting question to attempt to answer definitively. Some of the benefits that each type can provide over the other can be detrimental for certain businesses depending on products, type of service provided, and whether or not the store is wholly based online.

Likewise, some objections towards each type have workarounds that can not only fix the issue at hand, but make them better than the other.

As the answer is not all that clear cut and depends on merchant preferences, here’s some general thoughts:

It seems the most apparent reason merchants should encourage debit cards is to avoid higher credit card fees. But, this issue can not only be solved through surcharges, but actually make credit card payments cheaper than debit cards if used correctly. However, this would require extra work to set up, and surcharges can also prove unpopular to your consumer base if unfair or inconvenient to the product or service you provide.

One reason to prefer debit cards is the cheaper fees attached, added simplicity of service, and reduced fraudulent charges which means less chargebacks and unpaid service on your end. But, if your business is offering items or expert service that is on the more expensive end, then accepting credit cards might be a necessity. Many consumers rely on being able to use credit cards to make large purchases that they need to be able to break into monthly installments. Forcing your customers to have funds in full to make purchases can lead a great deal of customers out the door.

Given the endless variety of merchant offerings and the infinite wants/needs of consumers, it’s probably in every business owner's best interest to just simply focus on making the customer payment process as easy and seamless as possible. This means accepting both credit cards and debit cards. It could also mean staying wary of applying extreme surcharges, or minimum payments if it doesn’t make sense for your store.

While accepting both cards could mean increased fees, that price will become negligible when you develop faithful customers who leave your store happy after an effortless, inviting, and simple checkout experience that accommodates their different payment needs.

Interested in our payment processing? Heartland is the point of sale, payments and payroll solution of choice for entrepreneurs that need human-centered technology to sell more, keep customers coming back and spend less time in the back office. Nearly 1,000,000 businesses trust us to guide them through market changes and technology challenges, so they can stay competitive and focus on building remarkable businesses instead of managing the daily grind. Learn more at heartland.us