If you're in the market for a top credit card processing solution, you might have come across the terms "payment gateway" and "payment processor." While these are two key, related elements of credit card processing, they are not the same. If you're unsure of the distinction, you're not alone. However, to make an educated purchasing decision about your small business's ability to accept credit card payments, you need to understand the nuances.
This guide will introduce you to payment gateways and myths about payment processors, explaining how the two work together. If you plan to accept credit card payments online, you'll likely need both a payment gateway and a payment processor, so understanding each is critical to making the right choice for your small business.
Key parties involved in a credit card transaction
When a customer pays you with a credit card, a lot goes on behind the scenes among multiple parties. To understand how you need to set up your credit card processing, you should know who is involved.
- Issuing bank: This is the bank that issued the customer's credit card. When the customer uses the card to make a purchase, the issuing bank deducts the amount of the transaction from the customer's account and pays it to the acquiring bank.
- Acquiring bank: Also called the merchant account provider or merchant's bank, this bank is in charge of depositing funds from credit card sales into your merchant account. The acquiring bank deducts interchange fees from the purchase amount and pays them to the issuing bank.
- Card networks: These are credit card brands such as Visa, Mastercard and American Express. They set the interchange rates – the percentage of each transaction you pay for the ability to accept credit cards.
- Credit card processor: This is the entity responsible for coordinating and transmitting the purchase amount and merchant information from the merchant (you) to the issuing bank so it can then pay the acquiring bank.
- Payment gateway: A payment gateway is the technology that encrypts credit card information and sends it to the credit card processor.
What is a payment gateway?
A payment gateway facilitates online credit card payments and other transactions where the credit card is not physically present. It is the technology that creates a secure connection between your business's website or browser and the credit card processing company. Payment gateways usually have an interface when you can manually enter credit card information for phone sales; this is called a virtual terminal.
How payment gateways work
- The buyer makes a purchase with a credit card through virtual terminal or e-commerce site.
- The payment gateway's secure connection is used to encrypt credit card payment data and push it to the acquiring bank.
- The payment gateway determines which credit card network is involved and routes the transaction information to the issuing bank.
- The issuing bank verifies the authenticity of a transaction and determines if the buyer has enough credit remaining to cover the transaction amount.
- The issuing bank sends the approval or rejection of the transaction through the payment gateway to you.
Generally, you can set up a payment gateway in partnership with your chosen credit card processing company. When you set up a payment gateway through your merchant account provider, complications like compatibility issues are less likely. This is often the most cost-effective route for setting up a payment gateway. Usually, when you work through your merchant account provider, you can avoid payment gateway setup fees.
Some credit card processors have their own payment gateways, while others work with third-party payment gateways on behalf of their client businesses. One of the most popular third-party payment gateway providers is Authorize.Net. You should always check the terms and conditions before setting up a payment gateway so you know exactly how much it will cost you upfront, as well as on a monthly and sometimes even per-transaction basis.
What is a payment processor?
If you want to accept credit card and debit card payments from your customer online, over the phone, or at the point of sale, it is necessary to partner with a payment processor.
A payment processor is the company that handles the credit card and debit card transactions for a business. If the payment gateway moves encrypted data around, then the payment processor could be said to move the funds from one account to another.
Payment processors can be categorized into front-end and back-end processors. Front-end processors maintain connections to card networks and settlement services and manage merchant accounts on behalf of their clients. They contract with back-end processors who handle the actual movement of money behind the scenes.
Back-end processors primarily settle the transactions, moving money from the issuing bank (the customer's account) to the merchant bank, which ultimately transmits funds to the business's bank account when the transaction is finalized.
Payment processors' pricing structures and fees vary by the amount and value of the transactions you process and the model you choose. Generally, payment processors charge a percentage of each transaction, often adding a small per-transaction fee and a few other fees, such as a monthly statement fee, a monthly minimum fee and an annual PCI compliance fee.
Difference between payment gateway vs. payment processor
| Task/use | Payment gateway | Payment processor |
| Card-present transactions | Can be entered in a virtual terminal | Card inserted into a POS system or credit card reader |
| Card-not-present transactions (e-commerce, phone sales) | E-commerce transactions processed online or entered into a virtual terminal | Can be entered into POS system when the card's chip or magnetic stripe cannot be read properly |
| Encryption of information, sending transaction data to be processed | Yes | Yes |
Editor's note: Looking for the right credit card processor for your business? Fill out the below questionnaire below to have our vendor partners contact you about your needs.
Do I need both a payment gateway and a payment processor?
You might need both a payment processor and a payment gateway in order to accept credit card and debit card payments online. However, you can typically forgo the use of a payment gateway if you only intend to accept credit and debit card payments at a point-of-sale (POS) terminal. Virtual terminals accessed through your computer, though, require a payment gateway even if you only accept payment at the point of sale.
Is PayPal a payment gateway or a payment processor?
PayPal is what is known as a payment aggregator, and it has its own payment gateway, Payflow. You can learn more in our PayPal review. Payment aggregators do not require your business to set up a merchant account, unlike traditional payment processors. Instead, aggregators group your transactions with those of other merchants, essentially making you a submerchant on the aggregator's own merchant account.
Payment aggregators generally have a quick and easy application process and allow for much faster processing times than conventional payment processors. Fees tend to be more straightforward, and aggregators are often cheaper overall, depending on the amount and value of your transactions.
Unfortunately, payment aggregators are warier of risks and may place holds on your account if they detect suspicious activity or the increased possibility of chargebacks.
Unlike payment processors, aggregators generally offer fixed rates, so even as your transaction volume increases, the price you pay does not increase. Payment processors, on the other hand, typically offer more favorable rates to businesses with high transaction volumes or high-value transactions.
What is the difference between a merchant account and a payment gateway?
A merchant account is essentially an arrangement with the bank to create a space for pending transactions where the funds go before they are credited to your business's bank account. It is distinct from a payment gateway in that it doesn't transmit encrypted data, but rather the funds related to the transaction. The payment will temporarily be held in the merchant account as the transaction is finalized, at which point the funds will pass through the merchant account and into your business's bank account.
To set up your merchant account, a payment processing company will assign you a merchant ID number. This number is tied to the merchant account, which holds your funds until the settlement of a transaction. A merchant account is necessary to accept credit and debit card payments from your customers, unless you are operating as a submerchant with a payment facilitator, like Square or Stripe. To learn more, you can read our full review of Square and our Stripe review. So, while a merchant account is distinct from a payment gateway, it is often essential to accept both online and POS credit and debit card payments.
How should I choose a payment processor and payment gateway provider?
Selecting the right payment processor and setting up a payment gateway can seem complicated at first. There are many payment processors out there, all with their own pricing models and fee schedules. Navigating the sea of available services can be tough, especially for an entrepreneur concerned with the day-to-day operations of their business. [Check out our Clover review, National Processing review and ProMerchant review.]
To help you choose the right payment processor for your small business, business.com has established a guide to accepting credit card payments. We have also closely reviewed some of the leading payment processors on the market to come up with a list of our best picks. To find out more about payment processors and how to choose the right one for your business so you can start accepting credit and debit card payments, both online and on location, check out these links:
- How to Accept Credit Card Payments: A Beginner's Guide
- How to Accept Credit Card Payments Over the Phone
- The Best Credit Card Payment Apps for Android
The right credit card processor can make a big difference in your small business's revenue and your customers' satisfaction. However, it's important to investigate the market thoroughly to ensure you receive the best deal for your business. Whether that means accepting payments at the point of sale only or setting up a payment gateway for online transactions depends largely on the type of business you run and the volume and value of your typical transactions. Understanding the difference between payment processors, payment gateways and merchant accounts is the first step in making your customers' buying journey less complicated.
Adam Uzialko contributed to the writing and research in this article.