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Payment Gateway vs. Payment Processor

Adam Uzialko
Adam Uzialko
business.com Staff
Oct 29, 2019

What's the difference between a payment gateway and a payment processor?

If you're in the market for credit card processing solutions, 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, it's important to understand the nuances.

This guide will introduce you to payment gateways and payment processors, also explaining how the two work together. If you plan on accepting 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.

 

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What is a payment gateway?

A payment gateway facilitates online credit card payments. It is a technology that creates a secure connection between your business's website or browser and the credit card processing company. This secure connection is used to encrypt credit card payment data for every transaction, verifying the authenticity of a transaction and keeping sensitive information secure. In the modern world of digital business, the security of your customers' financial information is of the utmost importance.

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.

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, for example. Usually, when you work through your merchant account provider, you can avoid payment gateway setup fees. 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.

How does a payment gateway work?

A payment gateway works during online transactions by encrypting credit card information as it enters the payment gateway at the time of purchase. The encrypted data is securely sent to the credit card processor, the card network, the bank that issued the card and your business's bank. Once the encrypted data is delivered, the customer's card is charged the appropriate amount for the transaction. The funds are delivered directly to your business's bank account, minus the fees and processing costs you agreed upon with your credit card processor.

What is 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. 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 as well, and a few other fees, such as a monthly statement fee, a monthly minimum fee and an annual PCI compliance fee.

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.

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 card and debit card payments at a point-of-sale terminal. Virtual terminals accessed through your computer, though, require the use of 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, called Payflow. 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 potentially 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 a merchant account, a payment processing company will assign you a merchant ID number. This ID 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 card and debit card payments from your customers, unless you are operating as a submerchant with a payment facilitator, like PayPal, Square or Stripe. So, while a merchant account is distinct from a payment gateway, it is often essential to accept both online and point-of-sale credit card 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.

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 today 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 to start accepting credit card and debit card payments, both online and on location, check out these links:

The right credit card processor can make a big difference for your small business's revenue and your customers' satisfaction. However, it's important to thoroughly investigate the market 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 to making your buying journey less complicated.

Image Credit: jacoblund / Getty Images
Adam Uzialko
Adam Uzialko
business.com Staff
Adam Uzialko is a writer and editor at business.com and Business News Daily. He has 7 years of professional experience with a focus on small businesses and startups. He has covered topics including digital marketing, SEO, business communications, and public policy. He has also written about emerging technologies and their intersection with business, including artificial intelligence, the Internet of Things, and blockchain.