Here's What Happens Every Time You Swipe Your Credit Card

There are several intermediaries involved in credit card transactions, and they all get a cut of the money you spend.

When you swipe your credit card, it allows you to instantly borrow money for purchases and maybe earn rewards. But have you ever stopped to think about what is actually happening behind the scenes? Here's a rundown of what actually happens when you use your credit card to pay for a purchase, including which companies take a cut and how much the merchant actually gets.

The mechanics of a credit card transaction

Without getting too complex, let's consider what happens in a basic credit card transaction. To keep things simple, let's assume it's a domestic purchase made with a card issued by a U.S. banking institution, as foreign transactions add another layer of complication (this is why many credit card issuers charge foreign transaction fees).

There are generally four parties involved in a credit card transaction. These are:

1. The merchant
2. POS provider (Square, Toast, etc.)
3. Payment network (Visa, Mastercard, Amex, etc.)
4. Issuing bank

In a nutshell, when you swipe your credit card at a merchant's POS (point of sale) terminal, a payment network like Visa or Mastercard (or whatever logo is on the card) moves money from the issuing bank to the merchant's receiving bank account. It's also worth noting that in some cases, the payment network and issuing bank can be the same company. American Express and Discover play the roles of both lender and payment network, a system that is referred to as a "closed loop" payment network.

The flow of money

As we saw, there are several intermediaries in a credit card transaction, and it shouldn't come as a surprise that none of them provide their services for free. You likely already know that merchants pay fees when accepting credit cards -- anywhere in the 2%-3% range is typical. But many people assume that these "swipe fees" go to the payment network exclusively, while they actually get split among all of the facilitators of the transaction.

Let's say that you buy something for $100. While the exact fee structure depends on several variables, here's what happens in the average credit card transaction, according to data from restaurant POS provider Toast.

First, the POS provider collects an average of $0.77 (0.77%) of the transaction for providing the hardware and other infrastructure used to initiate the credit card payment. These companies often make additional money for providing software solutions to merchants, as well.

Second, the payment network gets an average of $1.19 (1.19%) for facilitating the movement of money between the customer's bank and the merchant's account.

Finally, the bank that issued the credit card, such as Chase, Citi, or Bank of America, gets an average of $0.73 (0.73%) as a fee for acting as the lender. So, even if you pay your credit card balance right away and have no interest due, the bank is still making money when you use your card. And in the cases of Amex and Discover, they get both the payment network and bank portions of the fee.

Here's a graphical representation of where the money in a credit card transaction flows:

When you add all of these fees up, the average merchant is left with $97.31 out of the $100 transaction. This means the typical merchant pays 2.69% of each transaction for the convenience of accepting credit cards. Some merchants have even started to pass these fees along to the customer -- if you've ever noticed a "credit card surcharge" on your restaurant check, this is why.

The bottom line

Accepting credit cards is a necessity of doing business for merchants, and that has become increasingly true over the past decade or so. Even though it costs money to accept credit cards, many businesses are happy to absorb the cost due to the higher sales volume it produces and the relative safety of digital payments. After all, cash has its own risks, such as theft and loss, that are important to consider in the context of credit card fees.