What Is a Merchant Account? Small Business Guide for 2022
This article is part of a larger series on Payments.
A merchant account enables you to accept credit card and debit card payments. It’s a bank account that serves as a liaison between your bank account and the customer’s. When a customer makes a payment with a credit or debit card, the funds are first transferred to a merchant account before they move over to the merchant’s financial account of choosing for withdrawal. This makes it easier to repay a customer if they dispute a purchase or are the victim of credit card fraud.
Merchant services include the merchant account and add other tools like encryption to increase security, payment processing, ACH transfers, gift cards, customer loyalty programs, payment gateway, the ability to accept credit cards online, mobile payment processing, and merchant cash advances.
Do You Need a Merchant Account?
If you want to make sales in today’s world, whether online or in person, the short answer is yes. Cash accounts for just over a quarter of purchases. While some of the move away from cash can be attributed to the rise of ecommerce, consumers are following the trend for in-person transactions, which still account for nearly three-quarters of all transactions.
Types of Merchant Services
The question, then, is not, “Do I need a merchant account,” but “What kind of merchant account should I get?” There are several kinds of merchant services.
Payment service providers, like Square or Payanywhere, charge a set rate no matter what kind of transaction you handle. They often include free tools like POS systems. They’re best for people doing occasional sales or have low monthly sales volume (<$10,000 month).
Merchant account providers usually work with higher-volume customers who need more personalized care. It’s common for merchant accounts to charge an interchange-plus rate by adding a small percentage or a few cents to whatever the credit-issuing bank charges. Rates, therefore, depend on the type of credit card or debit card being used and vary by transaction. These can save you a lot of money. Sometimes, the providers also charge a monthly fee, but even so, merchant accounts generally offer a better value for well-established and growing businesses.
Some banks, like Chase, have a merchant services division. You usually have to have a business checking or savings account with them, but get additional benefits such as immediate deposit of funds into your bank account.
Payment gateway providers (like Authorize.net) may provide only the tool to connect with your merchant account or may provide merchant services as well.
All of these types of accounts all fall under the umbrella term “merchant services.” Although they are technically different, In most cases, the term merchant account and payment processor are used interchangeably, as they both serve the same function of processing payments for businesses.
How to Find the Right Merchant Account
It’s important to do some research before choosing your merchant account because in some cases, you may be signing up for a long-term commitment. Follow these steps to help make the best decision.
First, know what to look for:
- Know your processing history: How much do you process in a month? How often do you need payment processing? What kind of processing do you handle most (online, keyed-in, card swipe or chip, non-contact payments?) Do you have high-ticket sales or low-ticket sales?
- Know your business: Are you in a high-risk industry? Do you have a history of chargebacks? Will you be online, in-store, or taking mobile payments?
- Know your needs: Do you also need a point-of-sale system? If you have one, how easy is it to integrate the merchant service? Are you planning to grow your online presence? Do you need to integrate payments with other business software like Salesforce?
Next, do your research. At Fit Small Business, we evaluate dozens of processors to find the best merchant services for small businesses, so you can make an informed decision. Also, ask colleagues in similar businesses what they use. Here’s what to look for:
- Fees: Some offer a simple flat rate per transaction; others offer interchange-plus. Some have monthly membership fees. Others charge additional small fees. Be careful, as one of the most common user complaints is being nickel-and-dimed to death with hidden fees. Ask to see a contract and follow up on any fees you don’t understand.
- Fee structure: Is the transaction fee by percentage, by cents, or a combination? If you do mostly small-ticket sales, then a percentage fee may be cheaper than a straight cents-added fee.
- Contract length: Ideally, your merchant service has month-to-month plans. However, if you are purchasing or renting equipment, are high-risk, or getting a really low rate, they may require a contract. These are notoriously hard to get out of, and expensive to forfeit.
- Services: Some merchant services include POS, virtual terminals, and more for free. Others charge for specific tools. Some even require a separate payment gateway that then adds its own charge to your processing fees.
- Quality of its apps: If you plan to use its POS system or app, check out the user reviews. Look for ease of use, complaints about downtime, and reports of withheld funds. For mobile apps, pay attention to whether it supports your version of Android or iOS.
- Ease of use: Merchant services should be easy to integrate and use, with intuitive software and an online system that makes it easy to see how much you spend on fees. Customer support should be available when you need them, especially if they supply you with your POS system.
- Complaints: It pays to check the experience of other users. We recommend the Better Business Bureau and Capterra when it comes to user review research. Keep in mind that the bigger the business, the more numerous the complaints; for example, there are thousands of complaints about Square and PayPal withholding funds, yet they serve millions of customers and are highly rated.
Finally, compare your top choices: Some make it easy because they list their prices and features right on the website. For those that don’t, you’ll need to call and give some basic information about your business. In those cases, always ask to see a sample contract and check for fees you don’t understand and the contract length.
Popular Merchant Services for Small Businesses
By far the most popular and highly-rated merchant service on our site, Square not only provides flat-rate payment processing and a free POS but also has a plethora of sales and business services. It’s a great option for retail, restaurants, service industries, and more. Crafters can use it to sell at the local farmers market, or stores can use it for online and in-store sales. Read our Square review to see why people love it.
Helcim is a popular merchant service that is featured on several of our lists, including the best retail credit card companies. Helcom provides free POS, a virtual terminal, and mobile payments apps as well as an online store builder. It offers interchange-plus pricing with no monthly fee and no contracts. See Helcim’s full review.
Stripe often makes our lists of best payment gateways because it’s such a highly versatile system. It integrates with over 650 software systems and is easy to program into websites. It can process 135 currencies. It has free invoicing, billing, and subscription services. It also has some financial services and a program to help startups. It’s best for those needing to accept payments online. However, it’s better for those with technical expertise. Read our Stripe review for more details.
PayPal gets a special mention because it not only provides payment processing for credit cards and other payments, but also has its own payment method. It works great alongside other merchant services, and in fact, studies have shown that including PayPal on your site increases your likelihood to close a sale. PayPal offers POS, virtual terminals, even credit cards and lending. It also pays directly into your PayPal account and has strong chargeback services. It ranks below Square for the best free merchant accounts for small businesses. Read our full PayPal review.
Applying for a Merchant Account
The good news is many merchant services don’t have a long application process. In most cases, if they charge a flat rate, you can sign up for them right away.
For those charging interchange-plus pricing, you need to apply. To make it faster, gather your information:
- Business contact information, including name, addresses, and DBAs
- How long you’ve been in business and your sales history (to help you get the best rates and plans)
- If you’ve used a credit card processor before and the information around it
- Financial information like tax ID, financial statements, bank accounts and routing numbers
- Credit card to pay the application fee
Next, contact the credit card processor. Some let you apply online; others have you talk to a sales associate who can take your information, discuss your needs, and give you a quote. Once you submit the information, the merchant service will run a check on your personal and business credit history.
Then, you’ll need to wait for approval. It can take up to two weeks, though usually less unless you have a high-risk account.
How Do Merchant Accounts Work?
To understand how credit card processing works, it’s first helpful to understand who’s involved:
- Merchant: The small business that is selling products and/or services to the end customer; they are the ones receiving money.
- Customer: The individual or business who is making the purchase; they are the ones providing money in exchange for products and/or services from the merchant.
- Merchant bank: The financial institution where the merchant keeps their funds.
- Payment gateway: Technology that allows merchants to securely accept credit card payments from customers.
- ISO/MSP: The Independent Sales Organization (also known as Member Service Provider) is a liaison between the card-issuing bank and the merchant.
- Issuing bank: The financial institution that provides the customer with their credit or debit card.
- Card association: Visa, MasterCard, American Express, and Discover are card associations.
The full credit card processing procedure—from when a customer presents a payment card to when the funds are deposited into your business bank account—can be broken down into three key steps:
Payment authorization is the process of verifying the customer account after the point of sale. After the customer’s bank validates the transaction, the card association and merchant bank are notified and a hold is placed on the customer account. Payment authorization and authentication happen automatically and behind the scenes, so business owners do not need to take any action with these first two steps.
At this point, the merchant’s POS or payment terminal can start the process of batching and sending out approved transactions for payment.
The settlement process is when the merchant actually gets paid. Many merchant services will batch and process transactions automatically, but depending on your processor, you may need to manually batch and settle transactions at each terminal at the end of the day. Either way, you’ll want to monitor all of your statements to make sure there are no outstanding authorized payments.
At this point, the merchant’s POS or payment terminal can start the process of batching and sending out approved transactions for payment.
Merchant Account Fees Explained
Credit card processing fees can be rather complicated because there are so many entities involved, and because the fees are not standardized between different merchant service providers. So, the types of fees you pay with one company might be completely different from the structure another merchant service provider uses.
Essentially, processing fees include the following:
- Account/service fee: Similar to a statement fee, this is a hidden cost companies add to cover their administrative expenses. It’s a good idea to try and avoid providers that charge these fees.
- Application fee: To open a merchant account, you first need to apply. In some instances, there are fees associated with the application process that the merchant account provider passes on to the merchant.
- Assessment fee: Calculated as a percentage of your total monthly sales, the assessment goes to the card associations. It’s non-negotiable.
- Batch fees: This may apply each time you settle your terminal. Inquire about the details of the batch fees and consider how frequently you batch your transactions (often daily).
- Chargeback fees: Chargebacks happen when a cardholder has been a victim of fraud. Merchant services providers will charge a fee for each instance. Multiple instances may also result in fines. According to Chargeback Gurus, when you consider all the other expenses involved, chargebacks cost an average of 2.5 times the sale price.
- Credit card payment processing rates: Fundera estimates the average card processing fees to be anywhere from 1.7% to 3.5% per transaction. Processing fees make up the bulk of the fees that you will pay to accept credit cards. Interchange and assessment fees are typically bundled into this rate.
- Equipment costs: You might already own compatible hardware. If you don’t, you’ll either need to purchase it on your own or from the merchant account provider. Many providers also offer the option to rent equipment, which may come with upfront and ongoing costs.
- Markup: Merchant services providers add an extra fee to what the card associations charge for processing. These are always negotiable.
- Minimum processing fee: Depending on your provider and selected plan, you may have to process a minimum amount in transactions. If you don’t hit this minimum, you may have to pay a fee.
- Monthly fee: Some merchant services, like Payment Depot, are upfront about their monthly fee and what you get in return. If this fee is not posted on their website but they charge it, then negotiate to get it removed or lowered.
- NSF fee: The not-sufficient-funds fee happens when a cardholder doesn’t have enough balance in their account to cover the amount of the transaction. The issuing bank will typically apply this fee to the cardholder, so this does not impact merchants.
- PCI compliance fees: Some providers charge a fee to remain PCI compliant, though it’s advised to find one that includes PCI compliance with their cost. Non-compliance could also result in fees around $19.95 per month plus additional fines should there be a breach.
- Setup/installation fee: When you get started with a new merchant services provider, it may have setup costs. These expenses can apply both for assisted on-site and self-installations.
- Statement fee: Again, this is a hidden cost similar to account, statement, and monthly fees. The best merchant service providers do not charge statement fees.
Learn more about different types of merchant service markups and what to expect for average processing rates, read our full guide on credit card processing fees.
How to Lower Credit Card Processing Fees
For starters, you can get creative and find ways to accept payments online for free. But that doesn’t work for in-person transactions. Here are some ways to get lower processing rates:
- Shop around. Do your research to find out who charges the lowest rates and which fee structure works for your average transactions.
- Ask. Sometimes your current business tools can negotiate their rates for you. This works especially well if you have a long and good relationship with your merchant services provider.
- Fight fraud. Look for ways to prevent chargebacks and other fraudulent activity so you don’t waste time and money on recovery. Many merchant services offer fraud protection tools, some free, some with an additional charge.
Merchant Account Trends for 2022
COVID-19 has changed how we shop, and those changes are continuing even as the world recovers. Here are some trends you can look forward to—or prepare for—for 2022:
- Visa and Mastercard to increase rates: Visa changed its rates in April 2021, and Mastercard plans to increase its rates in 2022. This will mean increased rates for interchange-plus accounts at least and may have trickle-down effects on flat rates.
- ACH Transactions: According to NACHA, consumers are increasingly looking for ACH, or bank-to-bank, transactions as a way to pay for items, including online. Not all merchant services offer this, so look for this feature, especially if you do B2B sales.
- Contactless Payments: This continues to rise, and is becoming a standard. Many card readers, like Square and PayPal, already have NFC payment capabilities. Contactless payments are also more secure than traditional swipe or chip payments because of the encrypted microchips in mobile apps.
- Embedded finances/brands-as-banks: Well-known brands like Amazon and Google are starting to create their own payment services. Other stores, like Target, are creating debit cards. Merchants will need to be able to accept these new types of payments.
- Social shopping: In 2020, Instagram launched its Shopping tab, and other social media offer buy buttons and other ways for consumers to sell through their platforms. IMRG, the ecommerce association of the UK, expects that social selling will only grow in future years. While PayPal is an easy way to add social selling, other merchant services are starting to enable social selling as well.
- Biometric authentication: The quest for increased security and multi-factor identification is leading to the increased use of biometrics for verifying payments. BiometricUpdate.com reports new technologies for facial and iris recognition as well as cards and banks adopting the technologies.
- Paying with crypto: In 2021, buying with bitcoin and other cryptocurrencies started to move into the mainstream, and many payment processors, like PayPal, have been quick to adopt this new currency.
Check out these other sources to help you plan for the future:
- Our industry report on the state of payment processing for small businesses.
- Online shopping statistics for how consumers prefer to buy online.
- Additional statistics on payment trends and customer preferences
Choosing the right merchant services provider for your small business is no easy feat. Though it may be tempting to go with the first one recommended to you or the one with the lowest rates, there are other factors at play. It’s important to think about security features, tech integrations, and chargeback management. Start by identifying your unique business needs and challenges, and then rank each option against your qualifications to make an informed, strategic decision.