Credit Card Processing

What Is a Merchant Account & How Does It Work? The Ultimate Guide

female business owner checking her small business merchant account
graphic of a relaxed man using mobile banking merchant accounts

A merchant account is a particular type of bank account that business owners must establish in order to accept payments. Currently, consumers’ most preferred payment methods are credit and debit cards. In 2021, consumers paid for 70 percent of their purchases with a credit or debit card.[1]Statista. “Market share of cash, credit cards, and other payment methods at point of sale (POS) in the United States in 2017, 2019, 2020 and 2021“. Accessed September 9, 2022. Worldwide, over one billion credit or debit card transactions occur every day. A business’s inability to accept card payments potentially dissuades an enormous portion of the consumer market from purchasing its goods or services. Perhaps the most essential element of modern payment processing, the first step to being a successful merchant is obtaining a merchant account.

In our ever-digitalized society, this type of account also enables business owners to accept various digital payment methods, including those made online, by eCheck, and with cryptocurrency. How can one little bank account do so much for your business? Below explains how a merchant account works, details its additional benefits, and outlines how to easily acquire one.

What Is a Merchant Account?

A merchant account is a specific bank account integral to payment processing. After obtaining this account, the merchant’s acquiring bank manages electronic payments channeled through their account. The acquiring bank holds unsettled funds in the account, settles transactions, then deposits settled funds into the business bank account. Essentially, transaction funds are stored until payment processing concludes, at which point funds are released to the merchant.

Once your account is set up, you’ll be issued a merchant ID number (MID). This unique 15-digit number helps to ensure the correct transaction funds are sent to the correct account.

What Are the Benefits?

  • Ability to accept numerous payment methods—most notably, credit and debit cards
  • Access to state-of-the-art hardware and software solutions tailored to your business’s specific needs
  • Capacity to support higher transaction volumes
  • Compatible to integrate with the most advanced payment gateways and virtual terminals on today’s market
  • Dedicated support from your account advisor
  • Ensured account longevity backed by a comprehensive underwriting process
  • Lowest available processing fees via the pricing plan best fitting your operations
  • Sophisticated security features protect against fraud and mitigate chargebacks

How Does a Merchant Account Work?

three business owners experiencing merchant account payment processing from a merchant services provider

To those unfamiliar, payment processing can seem like a magic trick. Your customer swipes, inserts, or taps their card, the transaction is authorized almost instantly, then—abracadabra!—you make money. This isn’t a sleight of hand, but rather several mechanisms working in tandem to effectively transfer complex data in the blink of an eye.

After your customer inputs their payment information, your payment processor collects and communicates the transaction details to your payment gateway, which secures this sensitive financial information. Then, your gateway transfers the encrypted transaction details to your customer’s bank to authorize the purchase. Your customer’s bank communicates the approval or rejection to your gateway, which transmits this information to your processor. Finally, the vehicle through which your customers input their payment information conveys said approval or rejection. This happens in mere seconds.

A rejection requires another payment method which flows through this process again. Meanwhile, approval does not mark the end of the processing journey. Your processor continues to work routing the transaction funds from your customer’s account, over the payment network, to your merchant account, where funds stay until settlement. Upon settlement, the payment process is complete, and your funds are released into your business bank account.

That is actually the short version. For a more detailed explanation, read our comprehensive guide on how credit card processing works.

Merchant Account Types

Before applying for a merchant account, you must select the type of merchant account for which you’re applying. Additionally, some businesses must obtain more than one merchant account due to their business practices. Whether you need just one or several accounts, below are a few of the most popular types of merchant accounts. As you read through these four types of merchant accounts, try to assess which would best suit your business needs based on your payment operations.

1. Retail Merchant Account

A retail merchant account best supports businesses with stationary, brick-and-mortar locations. If you own a business with one or more physical stores, this will likely be the most effective type of merchant account in supporting your operations. Because a majority of in-store payments are card-present transactions, retail merchant accounts typically incur lower processing fees than other types of accounts. Additionally, some providers will even supply you with a free in-store card terminal upon opening an account. (By some providers, we mean us. Partner with PaymentCloud for a merchant account and your first card terminal is on us!)

2. eCommerce Merchant Account

If online sales account for all or a majority of your transactions, an internet merchant account will aptly support your operations. In this case, your merchant account will be linked to a payment gateway, enabling your customers to input their card information on your checkout page. Payment gateways utilize several advanced security features—encryption, tokenization, SET protocol, and SSL technology, to name a few—ensuring the security of your business’s and customers’ sensitive financial information.

3. Mobile Merchant Account

If your on-the-go business, you need on-the-go payment processing via a mobile merchant account. With the use of a wireless card terminal or hardware that converts your mobile device into a terminal itself, a mobile merchant account enables you to accept payments anywhere, anytime.

4. MOTO Merchant Account

If you accept purchases over the phone, through email, or via mail order, a MOTO merchant account will support your operations. Typically, a MOTO merchant account will supply you with a virtual terminal through which you may enter your customer’s payment information and initiate the transaction. Even if you only have to manually enter a small portion of your transaction (for example, a restaurant accepting phone orders for takeout or delivery), it’s important to ensure the merchant account you choose gives you the ability to enter card-not-present transactions for processing.

How to Get a Merchant Account

In order to open a merchant account, a business owner must contact a merchant services provider. From there, you can then acquire all the mechanisms necessary to successfully process credit and debit card payments. A dedicated account manager oversees your relationships with these many moving parts required for payment processing, from initial application all the way to setup and integration. If issues arise, you don’t have to spend precious time contacting several entities to pinpoint the source of the error—your account manager does this for you!

Understanding Merchant Account Fees

graphic of a man wearing a tie and using a magnifying glass to inspect merchant account fees

The best things in life are free—however, this doesn’t apply to merchant accounts. When assessing merchant account fees, providers look at a range of factors, including your processing history, chargeback ratio, and credit score. Additionally, credit card networks will assign your business a merchant category code (MCC) to identify the business’s industry. When determining your processing fees, providers take the risk level associated with your MCC into consideration.

Providers typically charge your business via one of the basic pricing models: flat rate, bundled rate, interchange plus, subscription, or tiered. On your merchant statement, you should be able to locate your processing fees, pricing model, and other related information. (For a full breakdown of processing fees and pricing structures, refer to our credit card transaction fees guide.)

While these fees do cut into your business’s profits, the government has enacted policies aimed at protecting merchants from exorbitant processing fees. Particularly, the Durbin Amendment—an extension within the Dodd-Frank Act—restricts the interchange fees charged to merchants processing debit cards. Additionally, it’s important to remember processing fees are incurred in order to offer your customer base their preferred payment methods. In doing so, you should see an increase in your sales and growth in your customer base. The notion that the best things in life are free may not apply, but the adage that you have to spend money to make money certainly does.

Alternative Payment Solutions

Recent innovations offer alternative solutions to merchant accounts. However, these newer options are not tried-and-true. As such, there are a few pitfalls of which you should be aware if you’re considering an alternative to a traditional merchant account.

1. Merchant Accounts vs. Payment Service Providers

graphic of a man reaching for online funds from merchant account providers

Businesses can accept digital payments through a payment service provider (PSP). Even if you’re unfamiliar with payment service providers, chances are you’ve heard of the most popular ones on the market, such as Stripe and Square.

A payment service provider is an all-in-one solution to begin processing credit card transactions immediately. This immediacy forgoes underwriting. You begin processing transactions, and your business is underwritten after the fact. As such, a payment service provider may reject your application after you’ve begun processing payments on its platform, abruptly leaving you without a means to accept digital payments from your customers.

Additionally, payment service providers do not offer customization or flexibility. You cannot negotiate the terms, conditions, or pricing plan to which you’re subject. Because a payment service provider does not issue merchant accounts, but rather funnels funds through its own master account, you cannot tailor your account to the needs of your business.

2. Peer-to-Peer Payment Solutions

Not originally intended for business use, peer-to-peer payment solutions were created to facilitate the movement of individual-to-individual funds, not individual-to-business funds. As such, peer-to-peer solutions lack integrations, delay funding, restrict transaction volume, and do not offer the level of support business owners need. Ultimately, solutions like Venmo and Zelle effectively transfer funds but do little else in terms of supporting business operations.

Online Merchant Account: Final Thoughts

Despite alternative options, merchant accounts remain the leading method for offering your customers a variety of payment options. Customized to the precise needs of your business, your account is uniquely suited to support your business as it scales its operations. To get started, simply fill out our merchant account application today!

Whether you’re a completely new business or a seasoned veteran, we’re here to help.

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business owner with a merchant account and their various accepted payment methods

Frequently Asked Questions (FAQs)

What is the difference between a merchant account and a business bank account?

A merchant account holds unsettled transaction funds and incurs charges associated with payment processing. Meanwhile, settled transaction funds transfer from your merchant account to your business checking account.

Alternatively, a business bank account is your repository for all your business’s funds. Your business bank account is the final destination for your funds.

For more details, check out our guide explaining the difference between merchant accounts and business bank accounts.

Can I get a merchant account with bad credit?

Yes. You can get a merchant account with bad credit as long as you apply with a high-risk processor. These processors take other factors—aside from just credit score—into consideration, such as the length of time the business has been operating, the business type, its average monthly deposits, its average monthly processing volume, and other such factors.

What’s the difference between an acquirer and a processor?

An “acquirer” refers to the merchant’s acquiring bank. Simply put, the acquirer holds the merchant account into which it accepts unsettled transaction funds. Conversely, a “processor” facilitates all aspects of actually processing the transaction.

A single entity can offer both functionalities, but it’s important to clarify the two distinct functions between an acquiring bank housing a merchant account and a payment processor.

Can I accept payments online without a merchant account?

Yes, however, this is not ideal. If you accept payments without a merchant account, your options are limited to payment service providers, digital wallets, and peer-to-peer payment methods.

Can the funds in my merchant account be held or frozen?

Unfortunately, the funds in your merchant account can be held or frozen at the payment processor’s discretion. The most common reasons resulting in a hold or freeze on your merchant account are as follows: violation of your merchant agreement, a chargeback ratio in excess of the account’s chargeback threshold, suspicious or fraudulent activity, or surpassing processing parameters.

A merchant account hold or freeze can result in cash flow problems or, worse, the complete termination of your account. As a precaution, many processors will set aside a small portion of your funds from your merchant account into a reserve account.

Is PayPal a merchant account?

No, it is not. Though PayPal works similarly, it’s closer in definition to a digital wallet or money transfer service. PayPal can act as a payment service provider by holding unsettled transaction funds, but it does not issue separate merchant accounts. However, it is possible to use both PayPal and a merchant account.

How do I choose a merchant services provider for my business?

With so many payment service providers on the market, it can be difficult to choose the right one for your business. Thankfully, there are a few considerations to help narrow down your options.

First, consider merchant services providers with strong reputations and positive customer testimonials. Aim to rely on a credentialed provider you can trust.

Additionally, you want a provider that serves businesses like yours. If your business is considered high-risk, work with a provider specializing in high-risk processing.

What banks offer merchant accounts?

Many banks offer merchant accounts, including Chase, Wells Fargo, and Bank of America.

How long does it take to get approved?

The length of the approval process varies depending on the provider, your business’s details, and the type of account for which you’re applying. For example, high-risk merchants usually experience longer underwriting times.

Although some providers claim to offer “instant” merchant account approvals, this typically means that your account is provisionally approved. You will still need to undergo a full underwriting process afterward.

You may shorten the approval process by ensuring your application materials are complete and your credit is unfrozen with all three bureaus.

Can I get instant approval on my merchant account?

In short, no. Instant approvals do not exist. However, auto-approvals are most common for applications from low-risk retail accounts.

Article Sources

  1. Statista. “Market share of cash, credit cards, and other payment methods at point of sale (POS) in the United States in 2017, 2019, 2020 and 2021“. Accessed September 9, 2022.

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