How Does Debit Card Processing Work?

In the world of payment processing and merchant services, credit card processing most often comes to mind. According to a study conducted by the Cash Product Office of the Federal Reserve System, however, debit cards are the most used form of payment — accounting for 28% of all payments.

With consumers so often choosing debit cards over credit cards, understanding how debit card processing works can help you make an informed decision about whether or not your business should accept card-based payments.

On a basic level, debit card processing is the behind-the-scenes operations required for you, as a business owner, to accept a debit card as a form of payment from your customers.

Although the physical checkout process appears the same with both debit cards and credit cards — the customer presents their card, then taps, swipes or dips it and follows the required steps to complete the transaction — the actions occurring in the background are a little different.

On the whole, the operational difference between debit and credit card processing stems from the inherent difference between debit and credit cards themselves. Whereas customers paying with credit cards are pulling on credit lines from their card issuers, those paying with debit cards are drawing from funds that they currently have available through their linked bank account.

Overall, the behind-the-scenes debit card processing transaction can be broken down as follows:

• A customer submits their debit card to pay for a transaction.

• The card is dipped, tapped or swiped using a card terminal device.

• From this exchange, your point-of-sale system, or POS system, reads the card information and transmits the data to the customer’s card processing network (Visa, MasterCard, etc.).

• The processing network verifies the data and evaluates it for the possibility of fraud.

• The processing network then sends the data to the issuing bank (i.e. the bank that issued the customer’s debit card).

• The issuing bank confirms that enough funds are available and passes along an approval to the merchant or business owner.

Although this process may seem complicated, it occurs in only seconds — making debit cards (and credit cards) a very efficient form of payment.

Once the transaction is approved and you complete the checkout with your customer, the debit card network is then responsible for authorizing, clearing and settling the transaction with you, the merchant. In other words, the debit card network verifies the amount you’re owed and completes the process of sending the money to your merchant account. Typically this last part is completed quickly, sometimes even the same day.

Overall, the types of debit card processing are categorized by the way the card interacts with your POS system, and therefore, the way the data is transmitted and validated.

PIN debit transactions

This is typically the most common type of debit card transaction. When a customer chooses “debit” on the card terminal at checkout, they’re then prompted to enter their four-digit PIN to verify their identity.

With this verification, the transaction continues through the process above. These transactions are also called online debit card transactions because they use banking networks that correspond to the type of account attached to the card — a bank account.

Additionally, because they’re processed through debit card networks, PIN transactions usually have lower percentage fees and higher transaction fees, so they’re best for larger purchases.

Signature debit transactions

A signature debit transaction, on the other hand, is processed through credit card networks. When a customer chooses “credit,” their debit card information is processed through the credit card network, and customers are required to sign a receipt instead of typing in their PIN.

These transactions are also called offline debit card transactions because they do not correlate to the attached account.

Compared to PIN transactions, signature debit transactions typically have higher percentage fees and lower transaction fees, making them better suited for smaller purchases.

Contactless debit transactions

Contactless debit transactions, in other words, those that are made using a mobile device, smartwatch or contactless debit card are very similar to PIN transactions. The only difference is that the card, watch or mobile device is held up to an NFC terminal in order to communicate the necessary data present in the card or device.

Of course, with a smartwatch or mobile device, the actual debit card is linked to the device through a mobile wallet like Apple Pay or Android Pay. Once the card information is transmitted to your POS terminal, the debit card transaction process flow continues just like any PIN transaction.

Card-not-present transactions

The last type of debit card transaction is called a card-not-present transaction. E-commerce payments, keyed-in payments and card-on-file payments would all fall under this category.

Similar to signature debit transactions, card-not-present transactions are also processed through credit card networks. However, because there is not the same level of verification associated with this type of payment, they’re usually more expensive for business owners (with higher fees) and at a greater risk for fraud.

Debit card and credit card processing are completely unique processes, even when a customer chooses credit and goes through the signature debit transaction flow. Credit card processing involves a few additional players and steps.

When a customer uses their credit card, the data is sent to a payment processor before it moves along to the card network and the issuing bank. Then, instead of the issuing bank simply sending approval to the merchant, they send it to the card network, which sends it to the payment processor. At this point, the payment processor finally sends approval to the merchant.

Although this seems complex, the entire transaction flow takes place in mere seconds. The need for a payment processor stems from the fact that when a customer uses a credit card, they’re pulling on a credit line and not directly from existing funds in their bank account.

Therefore, instead of the bank taking the money directly from the customer’s account to pay the merchant, the payment processor pays the merchant (this usually takes a few days) and then later collects payments from the customer through their credit card agreement.

Because the credit card processing flow is more complex, it’s more expensive. Unlike debit card processing, credit card processing requires that you pay surcharge fees associated with the work the payment processor provides.

Conversely, because debit card payments are considered less risky than credit card payments — with fewer incidents of fraud and chargebacks — you’ll generally see lower fees for debit card processing.

While these are two separate processes that take place on different networks, in general, you can use the same POS hardware and software (and work with a single payment processing company) to accept both debit and credit card transactions.

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The cost of processing debit card payments varies based on a number of factors.

On the whole, the largest cost you’ll face with debit card processing is interchange fees, sometimes referred to as interchange rates. These are the fees that debit or credit card networks charge for the cost of processing transactions.

The interchange rates for any single transaction will depend on the size of the card-issuing bank. If the customer’s card is issued by a regulated bank (i.e. one with $10 billion or more in assets), the maximum interchange rate is set at 0.05% plus 21 cents.

With cards issued by an unregulated bank (less than $10 billion in assets), interchange fees are more complex. In this case, the fees can vary greatly depending on the size of the transaction, the merchant category code (i.e. your business’s industry) and other factors.

Whereas the maximum interchange rate for cards issued by regulated banks will apply to all debit cards regardless of the way they’re accepted — present vs. not-present, PIN vs. signature — the same is not true for cards issued by unregulated banks.

With these cards, you’ll find that PIN debit transactions have lower percentage fees and higher transaction fees, whereas signature debit transactions are the opposite. Therefore, PIN transactions are usually more affordable for larger purchases and signature transactions are more affordable for smaller purchases.

According to data from the U.S. Federal Reserve, the average interchange fee per transaction across all networks (for both regulated and unregulated cards) is 31 cents.

On top of the interchange fees that come from the card networks, you’ll also have to pay the payment processor markup — in other words, the additional fees a payment processor or merchant service provider charges for working with it.

The way these fees are issued varies from processor to processor, but they normally fall into one of three categories — flat-rate, tiered or interchange-plus. When it comes down to it, the interchange-plus pricing model is typically considered the most affordable, as you’re paying a fixed markup over the interchange cost for each transaction.

Use our guide to learn more about debit card processing fees.

Although the checkout process associated with accepting debit cards is fairly straightforward, there is much more involved when it comes to these card-based payments. Therefore, the best thing you can do to effectively and affordably accept both debit and credit cards at your small business is to work with a reputable payment processor.

The right payment processor — also sometimes referred to as a merchant service provider or merchant account provider — will be able to provide you with all the tools you need to accept card payments.

These companies will be able to work with you to find the right POS software, hardware or — if you’re an e-commerce business — payment gateway, that will allow you to accept and process debit and credit card payments. Note that payment processors will often charge additional fees for software, hardware, account maintenance and more.

Overall, these payment processors are typically separated into two categories — merchant account providers and payment service providers.

Merchant account providers, like Payment Depot and Payline Data, can offer more competitive interchange-plus pricing, but also require that you apply for an account and go through an underwriting process in order to get started.

Payment service providers (PSPs), on the other hand, like Square and PayPal, are fast and easy to set up. PSPs normally charge flat-rate fees, which although easier to understand, may end up being more expensive in the long run.

Ultimately, the right provider for you will depend on your individual business needs.