January 10, 2023
Processing credit card payments is critical in today’s advanced market. With over 1.3 billion debit cards and credit cards in the US, businesses cannot afford to accept only cash in the modern economy.
To successfully accept digital payments it is important to understand the ins and outs of chargebacks and how they can affect you. This article will explore the basics of chargebacks.
Unfortunately, there is no way to stop a cardholder from raising a dispute with their bank. Consumer protection laws within The Fair Credit Billing Act (FCBA) of 1974 cover cardholders. The FCBA protects consumers from unfair billing practices.
The FBCA protects consumers against paying for defective or missing goods, unauthorized transactions, unrecognized charges, billing errors, or fraudulent charges. It also enables individuals to dispute any charges related to these types of occurrences.
A chargeback occurs when a cardholder disputes a debit or credit card charge from your business. They can dispute a charge for any number of reasons including fraud, inaccurate billing, defective items, etc.
The cardholder will inform their bank and if the bank agrees with their client, the transaction is forcibly reversed. If the cardholder wins the dispute, the merchant account receives a debit for the transaction cost plus a chargeback fee. There are additional consequences your business may suffer from a dispute. Which we will discuss later.
Though many use these terms interchangeably, a dispute and a chargeback are technically different. A dispute is when a customer disagrees with a charge and informs their bank.
The chargeback is the action the bank takes to reconcile the customer’s dispute. The chargeback is the forced transaction reversal. It automatically removes the funds from the merchant account.
A payment or authorization reversal reverses an authorization hold. This means the transaction was not yet completed and the funds were not yet settled into the merchant’s account.
Conversely, a chargeback reverses a transaction after it is already settled. This means funds are forcibly removed from the merchant account and credited, sometimes temporarily to the cardholder.
Payment/authorization reversals do not damage merchant account standings. However, chargebacks not only have additional fees, but they can also damage merchant account standings with their payment processor.
To a cardholder, a refund and a chargeback have the same goal. Get their money back. Though these options may seem interchangeable to the consumer, a chargeback and a refund are very different, especially as it affects the merchant.
Cardholders need to understand the difference between the two.
A refund is when your business voluntarily reimburses a cardholder for a transaction. Because the merchant is approving the transaction reversal, there is no negative impact on their reputation with their payment processor.
A refund issues credit back to the customer and the item is generally returned. Depending on a business’s refund policy the return may not be necessary.
For merchants to avoid unnecessary chargebacks, it is important to write a clear return policy. And make reasonable refunds easily accessible.
Conversely, chargebacks are involuntary on the merchant’s side. Cardholders bypass the merchant altogether and request intervention from their issuing bank.
When a customer issues a chargeback, they are not obligated to return the item. As a result, the merchant not only loses the revenue from the sale but the value of the merchandise.
Additionally, merchants could lose out on overhead costs from shipping, fulfillment, and interchange. Lastly, the merchant will receive a debit for a chargeback fee from their processor.
The chargeback process can be potentially damaging to the reputation of a merchant account. Merchants should avoid giving cardholders any reason to file a chargeback.
Cardholders should only use chargebacks in extreme situations. Never to simply avoid the merchant when seeking a refund. They should be a last resort. If seeking a proper refund from the merchant proves impossible or if a card was really used for an unauthorized transaction.
There are a few cases when chargebacks can be necessary to protect a cardholder. In most cases, this would be in response to fraudulent purchases or unruly merchants. However, it is always best for customers to speak to merchants before filing a dispute with their bank.
For stolen or lost cards, consumers should contact their issuing bank immediately to prevent fraudulent charges. But for almost every other case, cardholders should directly reach out to the merchant before calling the bank.
Merchants can correct most mistakes or accidents with a simple phone call or in-person customer conversation. This route is more beneficial for both parties. The cardholder will receive their funds quicker than they would with a chargeback. And the merchant avoids a chargeback and strikes against their account altogether.
If you understand the most common reasons customers issue chargebacks, you can attempt to fix issues before they arise. Minimizing the risk of customers filing a dispute.
For stolen or lost cards, consumers should contact their issuing bank immediately to prevent fraudulent charges. But for almost every other case, cardholders should directly reach out to the merchant before calling the bank.
Merchants can correct most mistakes or accidents with a simple phone call or in-person customer conversation. This route is more beneficial for both parties. The cardholder will receive their funds quicker than they would with a chargeback. And the merchant avoids a chargeback and strikes against their account altogether.
If you understand the most common reasons customers issue chargebacks, you can attempt to fix issues before they arise. Minimizing the risk of customers filing a dispute.
A common reason customers file chargebacks is because the descriptor of a purchase is one they do not recognize. If a customer does not remember making a purchase that relates to a certain descriptor they may dispute it.
Sometimes the descriptor that bank statements have for a transaction may not accurately reflect the business. Make sure you and your credit card processor are aligned with your transaction descriptor.
Keep in mind, you may have an agreement on the correct descriptor for purchases with your processor. However, it is ultimately up to the cardholder’s bank how they post the description of the transaction on bank statements.
If your business offers subscription services, chargebacks can be very popular. Recurring billing can pose difficulty to many cardholders. Oftentimes figuring out how to cancel a subscription can be too much of a hassle.
Therefore, customers will issue chargebacks when they cannot stop the billing cycle. Be sure to have a simple cancellation procedure for your customers should they decide they no longer want their subscription. Otherwise, you will face costly chargebacks.
Unfortunately, a common reason for chargebacks is simply that a service or product is unsatisfactory to a customer.
Having a flexible return policy and easy return process will minimize customers’ chargebacks as a refund substitution.
Additionally, accurate product descriptions will ensure that customers know exactly what to expect with their purchase.
Friendly fraud—also called chargeback fraud— is responsible for most chargebacks. It occurs when a cardholder mistakenly or purposefully reverses a legitimate charge to recoup their money.
Because chargeback abuse is so high, merchants are more likely to experience fraud from their customers rather than from criminals.
There are numerous reasons for a cardholder to file a friendly fraud chargeback. For example, if the cardholder:
Friendly fraud is a critical issue. Moreover, not all consumer chargeback fraud is “friendly.” Consumers can deliberately abuse the chargeback system for a variety of reasons:
True fraud is when credit card information is stolen and used to make unauthorized purchases. Unfortunately, businesses cannot expect to win a dispute for true fraud.
Unless the cardholder is lying about the fraud and the merchant has contrasting proof. Such as a matching signature or photo evidence. Fraud prevention tools are an effective way to avoid credit card fraud.
When a merchant makes a mistake, customers lose trust. As a result, a cardholder may skip asking for a refund and go directly to their bank. Examples of merchant errors include:
With good business practices, merchants can better protect themselves from financial liability.
Depending on what reason the cardholder is filing a chargeback, there are different reason codes assigned to the case. Each credit card brand has different codes. The chargeback reason code provides distinctive information about the dispute category to both the acquirer and the merchant to help resolve the dispute.
If you receive a chargeback, it is imperative to review the provided reason code so you can take actionable steps to avoid future chargebacks. Especially for the same reason.
Visa Chargeback Reason Codes |
Mastercard Chareback Reason Code |
---|---|
30: Services Not Provided or Merchandise Not Received |
4837: No Cardholder Authorization |
American Express Chargeback reason Codes |
Discover Chargeback Reason Codes |
---|---|
F14: Missing Signature |
UA01: Fraud – Card Present Transaction |
For cardholders, chargebacks shield against dishonest business practices and criminal activity. For businesses, however, chargebacks can be a serious threat to revenue and sustainability. According to recent studies, by 2023, merchants will lose out on approximately $117 billion annually from chargebacks.
The initiation of chargebacks was to protect consumers from fraudulent transactions and merchants. But the reality is, even reputable businesses struggle with unfair chargebacks.
For merchants, chargebacks are a serious matter which could severely affect their business. What’s more, even if a merchant submits adequate evidence in the rebuttal portion of the process, the decision is out of the merchant’s control.
Over time, chargebacks could have serious negative effects on a business including:
Merchants not only lose investment costs, profit, and future revenue potential, but they also lose out on the costs paid to process the initial transaction. Including card processing fees, shipping costs, handling costs, etc.
When merchant accounts are terminated due to excessive chargebacks, they are added to the Merchant Alert To Control High-Risk (MATCH) list. Merchants on this list are thus, blacklisted. Which means it could be impossible to secure a new payment processor. At least for the next five years.
With this occurrence, a merchant’s only option would be to secure a high-risk merchant account, which usually comes with very high processing fees. However, even this can prove difficult once a business is on the MATCH list.
Merchants are not the only ones who are negatively impacted by chargebacks. Though chargebacks are designed to aid cardholders, consumers who file illegitimate fraud claims can also rack up negative consequences.
Now that we know what a credit card chargeback is and how it affects both sides, let’s dive deeper into how the chargeback dispute process works.
The chargeback processes can be challenging, and quite taxing on merchants. There are multiple parties involved and merchants are basically “guilty until proven innocent”.
What’s worse, is a cardholder can dispute a transaction months after the actual sale date. Which makes finding documentation difficult. Keeping accurate and organized records is extremely important.
The number of steps involved in the chargeback process will vary based on different factors. Such as the card brand used, the processor platform the merchant is on, the type of chargeback, and if the chargeback is an initial dispute or second chargeback.
Because different card brands have different rules on their chargeback process, merchant service providers can assist their merchants by providing them with accurate information from each card brand. Such as from the Mastercard and Visa chargeback guides.
With that being said, here are the basic steps involved in the credit card chargeback process :
The merchant’s acquiring bank forwards the chargeback to the merchant, giving them the option to plead their case. The processor will require merchants to send evidence either by email, fax, or mail.
The day a merchant receives the notification of a chargeback, their acquiring bank debits their account. Then, the cardholder receives a provisional credit until the final dispute decision.
After reviewing the chargeback information, the merchant can then choose to challenge or accept it. This decision is based on whether the merchant believes the claim is legitimate or not. And if they have sufficient evidence to fight the dispute.
Chargeback rebuttals can be time-consuming. However, if it is not done, a business can develop a reputation of being an easy target for fraud. Additionally, fighting illegitimate chargebacks result in revenue recovery.
If the merchant decides to challenge the chargeback, they will compile all relevant and requested evidence. This may also include a rebuttal letter. They will then send the information to their acquiring bank. The bank then reviews the documentation to ensure the merchant’s material meets the dispute requirements.
Some merchants conduct the chargeback rebuttal process internally. While others hire chargeback management companies for this purpose.
Whichever approach a merchant takes, it is important to keep organized and detailed records to help collect all the necessary documentation to fight any future chargebacks.
If the merchant wins the case with sufficient evidence, they will be re-credited the amount that was originally debited for the transaction. Minus any chargeback fees for administrative costs.
However, the merchant may lose the case due to insufficient evidence or other reasons deemed unfit by the cardholder’s bank. In this case, the merchant’s debit for the transaction is permanent and the cardholder receives the credit back.
If a cardholder loses their chargeback case, they can claim a second chargeback. Depending on their bank and the card network, this will result in pre-arbitration or arbitration.
Certain processors do not allow merchants to fight pre-arbitrations and it becomes an automatic loss for the merchant. Even if they won originally. Other processors allow the merchant to support the legitimacy of the transaction with further information.
With a maximum threshold, the pertinent question is, how many chargebacks are you allowed to receive as a merchant?
The industry standard is less than 1%. Preferably .65% or lower. If a merchant has a regular chargeback ratio of .9% or higher it could result in the above-mentioned network penalties.
For Merchants that are experiencing high volumes of fraud, the credit card networks must step in. For example, The Visa Fraud Monitoring Program (VFMP) is a system designed by Visa. It keeps these merchants in check. Incentivizing them to manage their transactions more carefully to reduce their chargeback rates.
Visa enrolls merchants who exceed 0.9% chargeback rates in the standard-level fraud monitoring program. Furthermore, Visa enrolls merchants above 1.8% in the excessive program.
From here, Visa may charge merchants additional fees. Or give the merchant automatic liability on all chargebacks they receive. Visa uses these penalties to urge merchants to enlist better practices. Reducing their fraud and chargeback rates.
How do you know if you are at an acceptable chargeback ratio? You will need to do some basic math.
To find your chargeback rate, divide the total chargebacks received by the total number of transactions within the same singular month. That will determine your chargeback rate.
For example, if you have 300 transactions for the month of November and 5 chargebacks you would divide 5 by 300 and your average chargeback rate would be .0167%. This would be below the standard maximum chargeback threshold.
The average win rate of a chargeback for a cardholder is 68%. This means that merchants only win about ⅓ of their chargeback cases.
Though the numbers seem to favor the cardholder, it is still important for merchants to always respond to their disputes.
In many cases, even honest merchants with legitimate transactions can suffer excessive chargebacks from customers. But how many disputes can a merchant respond to?
It is recommended that merchants dispute credit card chargebacks. Unless they believe the cardholder’s dispute is valid. Then they should not fight the dispute.
However, merchants must fight invalid chargebacks. Doing so will prove the legitimacy of their business to their processor, the card networks, and the issuing banks.
Additionally, it can dissuade consumers from filing illegitimate chargebacks when there is a high probability they will lose.
Certain industries are at higher risk of chargebacks than others. The highest ratio at an average of 0.66% is in the software industry. This can be because the majority of software is usually sold as a subscription. In many cases, customer’s either do not recognize the recurring charge or cannot figure out how to cancel the subscription.
The financial services industry takes second place in high chargeback rates at 0.65%. Third place goes to media and eCommerce at 0.56%. Following closely behind are the retail and travel industries at .50%.
Other industries that are at high risk for chargebacks include:
Because the chargeback process is time-consuming and even damaging to merchants, it is best to try to prevent chargebacks as much as possible.
Though a merchant has no control over a customer’s decision on disputing credit card charges, there are a few steps businesses can take to minimize their risk. So how do we reduce chargebacks? Let’s take a look.
Be sure your processor has your merchant account name correct. You want your store location name to match what customers see on their bank statements. If there is a charge with an unfamiliar merchant name, a customer is more likely to file a dispute with their bank.
Keep in mind, however, that it is the customer’s bank that makes the final decision. They decide how a transaction description reads on their customer’s bank statements.
If a merchant agrees with the chargeback and believes the customer is correct in disputing the transaction, then no. The merchant should not send in a rebuttal and let the chargeback play out.
However, if a merchant is sure the charge was legitimate and the customer received the proper service or product, they should always fight these chargebacks.
Merchants who do not respond to their chargebacks lose status with the card networks and can face penalties. Fighting chargebacks with accurate evidence puts good standing on the merchant’s account with the banks and can discourage future fraudulent chargebacks.
Chargeback threats can evolve and affect merchants daily. Because of this, merchants should have effective chargeback management and prevention strategies in place to save their account status and avoid paying additional fees.
It is valuable to partner with an effective merchant services company that has extensive experience in chargeback protection solutions. ECS can help you understand your credit card chargeback merchant rights and help manage your account effectively.
To contact sales, click HERE. And to learn more about ECS Payment Processing visit Banking.
Financial Writer
Magna Cum Lade BA, Communication, California State University Channel Islands.
Omega Alpha, National Communication Honors Society, Lambda Pi Eta
I spend the majority of my free time as a professional portrait photographer, traveling when I can, and focusing on physical fitness, weight lifting, and nutrition.
ECS Payments is committed to providing quality merchant services.
Our aim is to be a “One Stop Shop” for all payment and product needs.