Chargebacks

What is a Chargeback: Your Ultimate Guide to Credit Card Chargebacks

When you’re running a business, receiving a credit card chargeback is can feel like a major ordeal. However, chargebacks–while frustrating–are not all that uncommon. In fact, it is projected that friendly fraud will exceed $130 billion by 2023. While the growing rate of chargebacks and fraud can be linked to an increase in digital payments, these figures can be worrisome. Therefore, as a business owner, it’s important to understand the process of chargebacks and what they mean for your business. But what is the chargeback definition and is it the same as a credit card dispute? This guide will help you understand what a chargeback is, why they happen, and how to take proactive steps to prevent them.

What is a Chargeback?

chargeback definition

A chargeback, also called a credit card dispute, happens when a cardholder asks their issuing bank to reverse a charge. The funds are then charged back resulting in the merchant’s bank account being debited. Credit card companies originally let cardholders dispute credit card charges to protect them from unauthorized charges and fraud. Unfortunately, consumers often abuse this protection tool. This can cause problems for businesses, especially when the charges are legitimate or the service/product has already been delivered.

In the case of a disputed charge, the card issuer places the funds on hold from the merchant. The bank then conducts an investigation to decide whether to return those funds to the cardholder. If the bank finds the charges legitimate, the disputed funds go back to the merchant. However, the process can be tricky and time-consuming.

The history of the credit card dispute

The modern chargeback came about in the early 1970s when credit cards were much less popular than they are today. At the time, many people were skeptical of credit cards and feared they’d have their cards and information stolen. Granted, this was before the advent of chip technology as well as other digital payment advancements. Resultingly, cardholders didn’t want to be responsible for any unauthorized transactions.

Additionally, customers complained of shady merchants that took advantage of customers by adding charges to their credit cards. In response to this concern, the Fair Credit Billing Act of 1974 created the chargeback. This gave power back to cardholders who could now flag fraudulent transactions.

The Parties Involved in a Credit Card Chargeback

Credit card chargebacks involve three parties, each with its own unique role in the chargeback process. These are also the terms banks will use when detailing a credit card dispute.

1. The Customer (Cardholder)

The cardholder is the person who initiates the dispute of the transaction, which kicks off the chargeback process. This is the party whose account was debited the disputed charge. There are several reasons why a customer would take action against a transaction. We’ll break down the most common reasons cardholders submit credit card disputes later on.

2. Card Issuer (Bank)

After receiving a chargeback, the bank that issued the credit card will contact the merchant’s bank (acquirer) about the transaction. They will request additional information from the acquirer, such as the nature of the transaction, whether or not the cardholder signed a receipt, etc. If possible, the two banks will attempt to resolve the dispute.

3. The Business (Merchant)

The merchant is the entity that made the initial charge. When the merchant responsible for the disputed transaction receives a chargeback notification, they can do one of two things. The first is to accept the credit card chargeback and absorb the cost of the transaction. The other option is to fight the chargeback and submit evidence proving the charge was legitimate.

Chargebacks: Why do They Happen?

Credit card chargebacks generally happen for a few reasons. Here are the most common situations merchants see and measures to take that can reduce the chances of chargebacks.

Shipping issues

If a cardholder makes a purchase online and doesn’t receive it, they may decide to dispute the charge. Additionally, a customer may initiate a chargeback if they receive a damaged product or believe they were overcharged. As a business, you can reduce this type of chargeback by:

  • Keeping an accessible record of tracking numbers for every order
  • Requiring a signature on receipts
  • Making sure shipping policies on your website are accurate and up to date (ensure it’s easy to find and maneuverable to facilitate the customer experience)

Fraud

The risk of redit card fraud is a huge concern in today’s world. If a cardholder sees a charge for a purchase they didn’t make, there’s a good chance it’s fraudulent. This may lead them to submit a dispute. To prevent these types of disputes, ensure you:

  • Use a secure point-of-sale (POS) system with the latest security technology like chip and contactless payments
  • Train all your employees to accept payment cards securely with practices like always giving a receipt, confirming identification, and employing best practices for storing credit card information
  • Instead of allowing customers to swipe their cards, require the use of chip cards, which are more secure

Dissatisfied customer

A customer who is unhappy with the product or service they received may file a dispute. Disputed products often have a physical defect or failed to meet customer expectations. Services are more subjective, so it can be challenging to identify the root cause. You can prevent dissatisfaction disputes by:

  • Implementing a cohesive return policy
  • Advertising products realistically so customers know what to expect when they receive their items
  • Providing prompt and courteous customer service that a dissatisfied customer can easily contact

Recurring Revenue

what is a chargeback

Subscription-based businesses offer the benefit of recurring payments, expected revenue while offering your customers a unique product or service. However, the subscription industry is considered high risk. When a cardholder forgets to cancel a subscription renewal before the due date, they might issue a dispute. You can help prevent this type of dispute by:

  • Sending an alert, such as an automated email, when a renewal is about to occur. This alert should give the cardholder enough time to cancel the transaction if they so choose
  • Ensuring the billing frequency, refund, amount, and cancellation policies are clearly outlined in the recurring transaction agreement (RTA)
  • Making sure that cardholders understand what they are signing up with the RTA. If there is a way, add a signature line or checkbox in the agreement that they must acknowledge their understanding of

Why Chargebacks are Considered “Friendly Fraud”

Most often, search queries for “What is a chargeback” are usually followed by “What is friendly fraud?” Because of the abuse of the chargeback system by consumers, many people see chargebacks and friendly fraud as the same. There are consumers who intentionally claim fraud on legitimate transactions. As much as there are right reasons to initiate a chargeback, there are wrong ones too. The wrong reasons to file a credit card dispute include when a consumer has buyer’s remorse, finds the return process too cumbersome, or wants to avoid a restocking fee.

The Consequences of a Credit Card Chargeback

If your business receives a lot of chargebacks, its impact goes beyond just hurting your bottom line. That’s why your business needs a solid credit card chargeback strategy to avoid suffering the consequences. Below are just a few of the more devastating consequences of chargebacks.

High chargeback ratio

If your chargeback ratio is too high (the ratio of transactions that result in a dispute compared to normal transactions), your processor may issue a warning to get it under control. A recurring issue could put your business on a risk list, which is essentially a blacklist. Processors will review this list and avoid doing business with merchants who have a history of excessive chargebacks. Frequently, these merchants are only allowed to work with high risk merchant services providers.

Fraud

Chargeback fraud happens by mistake on the customer’s part. They may not recognize the purchase on their statement, forget they made the purchase, or let someone else the card without the cardholder knowing. This type of fraud will count toward your chargeback ratio and cost you time and money.

Chargeback fee

Unfortunately, most processors penalize businesses that consistently receive credit card disputes. This is because issuing the funds back to the cardholder can result in a lengthy process. Because of this, you may be charged a chargeback fee.

Can you Fight a Chargeback?

You’re not helpless when a credit card dispute occurs. Beyond giving an accurate representation of why the dispute is inaccurate, there are chargeback management tools out there that help you fight back against chargebacks. Here are a few ways to mitigate them:

  • Respond Quickly: The more responsive you are to a chargeback, the better. Make sure you have easy access to customer and purchase details
  • Be Proactive: If you’re seeing a pattern in your disputes, figure out these risks and take action to prevent chargebacks from recurring
  • Understand the Reason Code: The reason code tied to a chargeback gives more details on the evidence required, the amount of time you have to prepare your evidence, and more. Keep your reason code keys for each credit card issuer handy at all times.

Chargebacks don’t have to be the end of the world for your business. With chargeback management tools, fraud protection, and other mitigation strategies, you can keep chargebacks under control. Keeping your chargebacks in check will allow you to focus on what matters without the fear of consequences from your processor.



PaymentCloud Author Caroline McMullen

Caroline McMullen

Caroline is a writer and editor based in Los Angeles, CA. She has been working in the writing sphere for the last five years, covering everything from breaking news to lifestyle features, and now digital payments. Caroline is currently a Marketing Coordinator at PaymentCloud, a merchant services provider that offers hard-to-place solutions for business owners across the nation.