Everything You Need to Know About Payment Gateways and How They Work

Sep 15, 2022 by Izzy Howell

The payment processing system has many unique components that are all essential to ensuring that you, the merchant, are able to receive funds securely and efficiently from your customers.

Online businesses that accept credit and debit cards need payment gateways to verify payments and move from their customers’ bank accounts to the business’s bank accounts.

Here’s everything you need to know about payment gateways and how they work:

What is a payment gateway?

A payment gateway is an essential part of the process that allows your company to accept credit and debit payments from your customers. More specifically, a payment gateway is the gatekeeper of your customer’s specific payment data. It’s a technological mechanism that reads and transfers payment information from your customer’s bank account to your business’s bank account by capturing the necessary data and verifying that the funds for the desired transfer are readily available.

Payment gateways can be used both in-store and online. In-store payment gateways use software that has been built into a point-of-sale (POS) system, payment terminal, or card reader that processes the payment when a customer physically swipes, taps, or inserts her debit or credit card. Online payment gateways use cloud-based software to link customers to merchants in order to authorize credit or debit card payment processing.

How do payment gateways work?

Payment gateways are an absolute necessity for any company that wants to accept online and credit card payments from its customers. They use underlying technology to move financial data from one entity to another in order to fully authorize a payment and transfer funds from a payer to a payee.

Payment gateways involve a number of players, including merchants, customers, issuing banks, card schemes, and acquiring banks.

Let’s look at each of these players a bit more closely:

  • A Merchant is the business selling the goods or services being purchased by the customer (sometimes referred to as the cardholder).
  • The Issuing Bank is the bank associated with either the customer’s credit card or the account that’s tied to the customer’s debit card (or, in some cases, the customer will use the issuing bank for both).
  • A Card Scheme is the credit card company managing the credit card being used in any given transactions; common card schemes include Visa and Mastercard.
  • The Acquiring Bank or Merchant Acquirer is the bank tied to the merchant’s bank account, and merchant acquiring refers to the processes performed by the acquiring bank that enable transactions to fully go through and be protected.

A payment gateway is initiated when a customer hits a “buy now” button on your company’s website. The gateway ensures that there are enough funds available in the issuing bank before sending encrypted card information to the card schemes – something that allows the transaction to be fully processed.

Once the card schemes approve the transaction, the payment gateway transfers information back to the merchant website. Then, the payment gateway sends the information to the acquiring bank so that the money can be moved from the cardholder’s issuing bank account directly to the merchant’s bank account. Now, the transaction is done, and the payment processing is completed.

What is a payment processor and how do they differ from payment gateways?

Sometimes, it can be easy to confuse the difference between a payment gateway and a payment processor. These are two distinct elements in the payment process that allows businesses to accept credit and debit card payments, but they both work together to make it possible for customers to pay for goods and services using their debit and credit cards.

As we stated above, a payment gateway will check with the issuing bank to make sure that the customer’s funds are available and that the desired transaction won’t exceed her credit limit or her bank account balance after the customer has decided to initiate a transaction. The payment gateway then sends these encrypted customer details to the payment processor.

Payment processors (also known as merchant processors) are vendor businesses that manage the process of accepting credit and debit card payments. They act as the middlemen between the merchant and the financial institution involved. They also authorize payments by verifying your customers’ billing information, confirming the funds are available, and finally, transferring the money to your own merchant acquirer. Many people wonder, “what is a merchant acquirer?” But this is just another name for the bank that’s associated with your business’s bank account.

To learn more about payment processors and how they work, be sure to read our blog here.

What are the different types of payment gateways?

There are three types of payment gateways, including redirect payment gateways, hosted payment gateways (these are located off-site), and self-hosted payment gateways (which are hosted on-site).

Let’s take a closer look at each one of these

  • A redirect payment gateway might include different payment options by taking your customer to a payment processor like PayPal or Stripe to process your transaction.
  • A hosted payment gateway allows your customers to make purchases on your website or at your store, but the payment is processed through your payment provider’s servers instead of your own.
  • Self-hosted payment gateways tend to be used by large companies that use on-site payments because these types of transactions happen on the individual company’s servers.

How can you choose the best payment gateway for your business?

When it comes to choosing a payment gateway, you’ll need to ensure that the partner you choose is PCI compliant, secure, and offers all the features your business is looking for. Plus, it’s also helpful if the vendor offers both a payment gateway and a merchant processor in the same offering.

Here are a few things to make sure of when it comes to choosing the right payment gateway for your business:

  • The payment gateway should be available in your geographic region
  • The payment gateway should integrate easily into your ERP system, website, financial software, and point-of-sale (POS) software
  • The payment gateway should keep all financial data secure and be PCI compliant
  • The payment gateway should accept the payment methods your customers want to use

What does the future look like for B2B payments?

While payment gateways are essential to allow your company to securely process credit and debit card transactions, the future of B2B payments is one that eliminates the need for credit cards and the punitive fees associated with them altogether.

If you’re ready to explore new B2B payment options that are cashless, feeless, and frictionless, you can request a demo with us here.