Digital payments can take many forms, including card payments, mobile wallets, integrated online payments, or in-app transactions. For both physical and online payments, it is really important to verify the legitimacy of each transaction and protect cardholders from fraud and identity theft.
This can only be achieved when the transaction verification process is reliable. A payment is not finalised until the customer’s bank confirms that sufficient funds are available to transfer to the business’s account. This back-and-forth communication between banks is crucial for successfully processing a transaction, and it is the payment processor that facilitates it.
In this article, we’ll explore what a payment processor is, how it works, the different types available, and how to choose the best one for your business. We’ll also break down the associated fees so you’re up-to-date with the correct information.
What is a payment processor?
When a customer makes a purchase using a digital method, the payment processor uses the provided payment information to communicate with both the customer’s bank and the business’s bank to carry out the transaction. Payment processors allow businesses to offer multiple cashless payment options, like credit cards, debit cards, mobile wallets, and online transactions from home. This variety in payment methods targets a broader customer base and improves the overall customer experience.
Many payment processors also provide analytics on customer behaviour, payment activity, and shopping patterns. These insights are valuable for businesses because they help manage finances more effectively and better predict customer preferences.
Payment processor vs a merchant account vs a payment gateway
| Aspect | Payment Gateway | Payment Processor | Merchant Account |
|---|---|---|---|
|
Function |
Acts like a virtual checkout terminal for online transactions. |
Connects with banks and card networks to authorise payments. |
A special business bank account that holds funds temporarily. |
|
Where It’s Used |
Mainly used in online transactions. |
Used in both online and in-person payments. |
Used after the payment is authorised. |
|
Key Role |
Sends the customer’s payment data securely to the processor. |
Finalises the payment by sending authorisation requests. |
Stores funds for 1-3 days before transferring them to the business’s main account. |
A payment processor does not work alone; it functions along with other components like a payment gateway. That’s why it’s important to understand the differences between the major parts involved in a payment. After this section, we’ll look at how a payment processor works in more detail, and you’ll see how the payment gateway and merchant account also play important roles.
Payment gateway
The terms payment gateway and payment processor are often used synonymously, but they have different purposes. During the transaction processing, the payment gateway comes before the processor. Here is what it does:
- A payment gateway acts like a software-based checkout terminal, like a virtual card machine for websites or applications.
- It securely transmits payment data like the customer’s card information, CVV, password, or PIN to the payment processor. So, the payment gateway mostly handles the security aspect of online transactions.
- Physical card machines often have built-in security features, so in-person transactions often do not involve the need for a separate gateway.
Payment processor
Whether the transaction starts online (through a payment gateway) or in-person (through a physical terminal), the processor is the one that connects to card networks and banks to get approval. This means it is required in both remote and physical transactions.
- It also plays a role in maintaining data security, along with the payment gateway.
- Payment processors enforce fraud checks but usually do not handle initial encryption. At this point, it has already been handled.
- Some companies combine the gateway + processor into one service, which leads to confusion.
Merchant account
A merchant account is different from a payment gateway. The primary difference is that a payment gateway is a software-based tool, while a merchant account is an actual bank account held by the business.
- After authorising the transaction, the payment processor transfers the funds to the merchant account.
- The account temporarily holds the money for a specific time (usually 1 to 3 days) before it is transferred to the business’s main bank account.
How does a payment processor work?
All three components, gateway, processor, and merchant account, work together to finalise the transaction. Here’s how the process goes:
- The customer makes a purchase and chooses a card as the payment method. They provide the relevant data, like their account number and PIN, to proceed.
- The payment gateway receives this information and applies security methods like encryption and tokenisation to securely transmit it to the payment processor.
- The payment processor sends an authorisation request to the customer’s bank. The bank either approves or declines the transaction and sends the message back to the business’s bank. All this communication is done via the payment processor.
- The payment processor completes the verification process and transfers the funds to the merchant account.
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Types of payment processors
It’s important to understand the different types of available payment processors so you can choose the most suitable one for your business.
1. Payment service providers (PSPs)
These include popular UK payment processors like PayPal and Square. These offer a combined solution (payment gateway, processor and merchant account all-in-one) for all types of cashless payments.
Payment service providers handle everything from accepting payments to processing and transferring funds. It makes them ideal for small businesses that want to avoid managing different things and are looking for a quick solution for digital payments.
2. Integrated payment processors
Payment gateways like WorldPay are designed for businesses which need to accept remote payments. They offer combined payment processor and gateway services, along with physical card machines for physical transactions. They often provide portable card readers which can be connected to mobile devices to process transactions anywhere.
How to choose the best payment processor?
When choosing a payment processor, make sure you consider the following things:
1. Evaluate the fee structure
When choosing a payment processor, look beyond the basic fee structure of transaction fees. Consider evaluating the overall cost breakdown, including setup fees, monthly fees and any hidden charges. This will help you understand the long-term costs instead of only focusing on short-term charges. Before finalising a payment processor, compare different providers to get the best deal for your budget.
Smart tip: Consider the volume of transactions your business processes and see which fee structure suits you the most. E.g. the percentage structure or the fixed transaction fee structure.
2. PCI compliance and fraud prevention protocols
Ensuring PCI compliance and robust fraud prevention protocols is essential. PCI compliance guarantees that the payment processor adheres to industry standards for protecting cardholder data. The fraud detection tools keep your business and customers protected from fraudulent transactions and potential financial losses.
3. Whether you need POS
Think about whether your business needs a Point of Sale (POS) system. If you run a brick-and-mortar store, a POS system can streamline in-person transactions and manage inventory. Some payment processors offer integrated POS solutions that sync with your online store while others provide separate functionalities. Choose accordingly.
Make sure to choose a payment processor that supports your POS hardware, whether it’s mobile, countertop or a more complex setup.
4. Customer support
Look for a provider that offers 24/7 support through various channels such as phone, email and live chat. Reliable customer service ensures that any issues are addressed promptly, minimising downtime and keeping your business running smoothly.
Smart tip: Check online reviews and testimonials on platforms like Trustpilot to gauge the quality of their support.
5. Accepted payment methods
Another important consideration in choosing a payment processor is the accepted payment methods. Your customers, especially if you have an e-commerce business, are paying through different methods. The processor should be able to process them e.g. debit cards, digital wallets, credit cards, etc.
Fees for payment processing
As a business owner (or merchant), you have to keep in mind the fees of online payment processing because only then can you see which payment processor is suitable for you and whether employing a payment processor is profitable for your business. Here is the list of fees.
- Interchange fees: These are the fees the acquiring bank pays to the issuing bank. This fee is set by the card brands like HSBC and is non-negotiable. The interchange fee is different according to the card levels.
- Transaction fee: This is a set network fee added to each transaction. It’s either a percentage of the purchase or a fixed number or a combination of both.
- Setup fees: These are one-time charges for setting up your account and integrating the payment processor with your business. Some providers don’t charge it while others do.
- Other fees: It includes other variable fees like cancellation fees, chargeback fees, international fees, etc.)
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FAQs
A payment processor provides various benefits like faster card payment processing, reduced risk of fraud, better customer experience and streamlined operations. It ensures funds are quickly and accurately transferred to your business account.
Yes, payment processors can hold funds temporarily. This usually occurs for security reasons, such as fraud prevention, verification of large transactions, or when your account is new. Once the review process is complete, the funds are released to your business account.
Payment processors get paid through various fees, including transaction fees (a percentage of each sale, a fixed amount or a combination of both), monthly fees (some payment processors take them), chargeback fees and setup fees.
