Merchant Accounts 101

Q: What is a Merchant Account?

Quite simply a merchant account allows your business to accept credit cards. Typically this is used to describe the ability to accept Visa and MasterCard credit cards but does also include American Express, Discover Card, and other types of credit cards.

Q: What is a third party processor?

A Third Party Processor is a company that allows you to use their merchant account to accept credit cards for your business. The merchant account is theirs and therefore they set the rules you must abide by. They are also responsible for ensuring that you receive payment for your sales and for debiting your account for fees as well.

Paypal, Worldpay, and 2CheckOut are some examples of a Third Party Processor.

The benefits of Third Party Processors are primarily in their cost benefits to small businesses. Since most Third Party Processors only charge processing fees and nothing else (like monthly fees or annual fees) they keep billing simplified and costs low for small businesses who don’t have money to throw away for nothing (like an annual fee). They also tend to supply everything a merchant needs to process sales online with no other accounts required.

The downsides of Third Party Processors are pretty severe relative to a true merchant account. Since Third Party Processors assume all risk associated with your account and therefore they tend to have very strict policies on risk which frequently allow them to seize and hold money on a whim. Their processing fees are also very high on average and can take quite a chunk of a merchant’s sales if they are processing more than $1,000 a month.

Q: Should I get a true merchant account or use a third party processor?

This all depends on your business needs. The easiest way to determine which is best for your business is to base your decision on your average monthly processing volume. Generally, if your volume is over $1,000 per month you should establish a true merchant account. This is because even though you will incur extra fees for your monthly statement and processing gateway, you will still save money versus Third Party Processors and will have much more flexibility with the whole process. Third Party Processors will save small merchants money only because even though their processing fees are higher they charge fewer fees overall (they typically do not charge monthly fees or gateway fees).

What you should do when comparing any processor to another one, whether they are a true merchant account provider or third-party processor, is to take the core fees you will be paying (see below) and do the math for your business. Typically knowing your businesses average ticket size and estimated monthly number of sales will allow you to make a comparison of what you will pay with one processor vs another.

Q: What kind of rates and fees should I expect to be paying?

In the world of credit card processing, there are a lot of potential fees and costs that you may encounter as a merchant. However, 99% of merchants won’t see the vast majority of these fees so we’ll cover just the ones that significantly affect the majority of merchants.

The most common fees that affect merchants are:

Discount Rate – Also known as the Percentage Rate this fee takes a set percentage of a merchant’s sale as a fee for processing that transaction. Retail stores typically pay between 1.60% – 1.80% per transaction. Mail Order and Internet businesses typically pay 2.10% to 2.30% per transaction. Third party providers typically charge between 2.80% – 5.00%. This fee affects higher ticket merchants the most.

Per Item Fee – Also known as a Transaction Fee this fee is a flat fee charged every time a transaction is processed. This fee is typically between 20¢ – 25¢ for retail business, 25¢ – 35¢ for Mail Order and Internet businesses, and up to $1.00 for third-party processors. This fee affects lower ticket merchants the most. It is possible for this fee to not be charged to a merchant but is rare and at the expense of having a higher discount rate.

Monthly Fee – Usually referred to as a Statement Fee this is a flat fee a merchant pays each month to keep their merchant account active. This usually includes a statement being sent during the month that breaks down the merchant’s processing history for that month, customer service, and technical support. This fee typically runs between $5 and $15.

Annual Fee – Also known as a Membership Fee (and many other names) this fee is charged to a merchant simply for keeping the service open for a full year. This fee is not required by Visa and MasterCard.

Monthly Minimum – This is a fee which guarantees the merchant will be paying a minimum amount each month in processing fees. If a merchant’s discount fees do not equal their monthly minimum fee they will be charged the difference between the two in addition to their discount fees.


A merchant has a discount rate of 2.50%, a monthly minimum of $25, and a monthly volume of $600. The discount fees for the month will be $15.00 (.025 * $600). Because their discount fees are less than their minimum fee ($15.00 < $25.00) they will be charged an additional $10.00 as a monthly minimum fee ($25.00 – $15.00).

This fee is not required by Visa and MasterCard.

Q: How long does it take to open a merchant account?

Believe it or not, the process of establishing a true merchant account is usually fairly quick and easy (assuming your sales agent is knowledgeable in what they are doing). An account can be opened in as little as four hours or as long as a few days depending on when the application is submitted and the underwriting guidelines of the processing bank. The application process should never take longer than that without a clear and legitimate reason. If your application is taking two weeks to be approved and you’ve had little to no communication with your sales agent, something is wrong and you should consider canceling your application.

Establishing a third party account will vary from provider to provider as each has its own criteria and verification process. Your account can go live anywhere from immediately to several days or weeks. Also, the services made available to you may depend on verification of your business or personal information.

For planning’s sake, the process setting up of a merchant account should be started two or three weeks before you expect to “go live”. This will allow for unexpected delays and testing of the account and gateway.

Q: What is a Reserve?

A reserve is when a bank holds a portion of a business’ sales and sets it aside. This is money that is normally deposited into a merchant’s account. This money can be a set amount or a percentage of a merchant’s monthly volume (also known as a rolling reserve). This money is usually set aside to offset the risk a merchant account poses. Reserves can be temporary and the funds returned to the merchant (typically this doesn’t happen until the merchant has processed for at least six months) or permanent and the funds are not released until six months after the merchant account is closed.

Q: What is a Cancellation Fee?

Just as the name implies a Cancellation Fee is charged if you were to close your merchant account before reaching the end of your contract agreement (which can be anywhere from one year to five years with three years being typical). The amount for this fee varies and should be considered before choosing a merchant account provider. An average cancellation fee is around $300. However, some merchant account providers will charge up to $800. A cancellation fee over $300 is excessive and should be considered a negative factor when choosing a provider. A cancellation fee under $300 should be considered acceptable. Some merchant providers do not have a cancellation fee, however, this is rare. Others do have cancellation fees that decline in amount as the end of the contract nears.

Q: What is a Chargeback?

A chargeback occurs when a customer contacts a credit card-issuing bank to initiate a refund for a purchase they made on their credit card. The reasons why chargebacks arise can vary greatly but generally, they are the result of a customer being dissatisfied with their purchase. The customer may or may not have contacted the merchant about remedying this situation ahead of time. They may even be completely wrong. However, the responsibility falls to the seller to ensure that the transaction goes smoothly and the customer is satisfied. A failure somewhere within the fulfillment process, including at the customer service level, can lead to a chargeback.

Q: What is The Match File?

The Match File is a database file used by MasterCard and Visa processing banks to identify specific merchants and owners who have had their merchant accounts terminated. Once a merchant is on this list it is highly unlikely that future merchant account applications will be approved. The Match File is essentially a BLACKLIST from which it is almost impossible to be removed.

For a business or merchant to be added to the Match File they need to violate Visa and MasterCard rules in some way. The most common reasons include:

– Fraud

– Factoring (ringing sales for another business)

– An excessive number of chargebacks

– The processing bank concludes that serious violations of the merchant agreement could result in increased loss exposure to itself or the credit card community.

Once a merchant has been placed on The Match File only the processing bank that added them can remove them from it. The merchant must work with them directly to accomplish this.

You do not want to be on the Match File!

What you can’t-do with credit card processing.

Just because you have a merchant account doesn’t mean you can do anything you want with it. Visa and MasterCard have guidelines governing their use. Here are some things you cannot do:

•Personal Use – Visa and MasterCard do not allow their services to be used for personal reasons. All accounts must be established for one business and to be used only for that business’ products and services. An account cannot be established for an individual nor can a merchant use their merchant account for personal reasons.

•Factoring – Visa and MasterCard do not allow more than one business to use a merchant account. All accounts must be established for one business and to be used only for that business’ products and services. When a business processes transactions for another business, even if they own that business, they are “factoring”.

•Charge More for Credit Card Transactions – Visa and MasterCard does not allow a merchant to charge more for products/services paid for by their credit cards. They do not want to pay by credit card to be seen in a negative light.

If a merchant wishes to offset the additional costs of accepting credit cards, they should do one of the following:

•Increase prices on their products/services for all purchases

•Increase prices on their products/services and then offer a cash discount

Charging a convenience fee for accepting credit cards is not considered acceptable.

•Set a Purchase Minimum – Visa and MasterCard do not allow merchants to set a minimum purchase amount for which credit cards may be used. For example, a merchant may not declare that a purchase must be at least $50 in size in order to use a credit card for payment.

Q: What is a Gateway?

In short, a gateway connects your ecommerce Website to your merchant account.

The gateway facilitates online payments by connecting your secure order form with your specific merchant account at a processing bank. The gateway takes the submitted form data and presents it to the processing bank. When it receives a response from the processing bank, it presents that return data to the site of origin for appropriate handling.

The gateway itself doesn’t provide ecommerce features such as shopping carts, Web hosting, or merchant accounts, although many larger gateway providers do offer additional services like these.

Popular gateway providers include, Verisign, Plug ‘n Pay, and LinkPoint.

Gateways like does not provide merchant accounts! They are two very different and separate things. Both are very complex to offer and thus are offered as separate services.

I want to process my Internet sales without using a gateway.

Visa and MasterCard forbid Internet merchants from using software or equipment that does not support the Electronic Commerce Indicator. Electronic Commerce is when the cardholder’s information leaves the possession of the cardholder and travels through an open connection, such as the Internet, to reach the merchant. In order to designate this type of transaction, the Electronic Commerce Indicator (ECI) must be included in the payment transaction message format to show that the transaction originated from an Internet source. This indicator is assigned in the point of sale product utilized by the merchant. Credit card information sent via email does constitute a transaction needing the ECI in the transaction to the processing bank.

Visa U.S.A. introduced a penalty structure effective June 1, 2000, for acquirers who fail to identify an electronic commerce transaction with the correct electronic commerce indicators. MasterCard International introduced a penalty structure effective August 1, 2000, for acquirers who fail to identify an electronic commerce transaction with the correct electronic commerce indicators.

If a merchant’s software sends an ECI (values of 5, 6, or 7) the transactions are noted as a secure ECI transaction and must be using a secure form of processing card data. These transactions are eligible for CPS rate programs. If the software sends up an ECI value of 8 or 9, the merchant is processing the card data in a non-secure format and the transaction cannot qualify better than EIRF (i.e. the highest rate you can pay for a transaction).

All terminal products that are certified to pass an ECI send a value of 8 because this is a non-secure way of processing electronic commerce transactions. But there aren’t any credit card terminals currently supported to handle ECI. This means you must use special software or a gateway only. Visa and MasterCard employ 250 employees whose sole purpose is to find web merchants who violate this policy. Violating could result in fines, your account is terminated, and/or you being blacklisted for accepting credit cards.

Other Definitions

ADDRESS VERIFICATION SERVICE – A service that verifies the cardholder’s billing address in order to combat fraud in mail order/telephone order transactions.

BATCH – A grouping of credit card transactions as captured by a merchant. A batch is usually an entire day’s activity.

CARDHOLDER – Merchant’s customer who holds a credit card. The person to whom a financial transaction card is issued or an additional person authorized to use the card.

DISCOUNT RATE – A percentage rate that merchants are billed for the processing of Visa or Mastercard transactions. This discount rate can be applied to net or gross sales.

MERCHANT – Any business that, having met the qualification standards of MasterCard and/or Visa and having been approved by any acquiring member, accepts MasterCard and/or Visa cards as payment for goods and services.

RECURRING TRANSACTION – A transaction charged to the cardholder (with prior permission) on a periodic basis for recurring goods and services, i.e., health club membership, book-of-the-month clubs, etc.