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Credit card chargebacks occur when a customer disputes a transaction and asks the credit card issuer to reverse the charge.
While credit card chargebacks are a useful way to protect consumers from unauthorized transactions, they can be a major headache for business owners — especially when the chargeback results from fraud or an error. This guide is designed to help small business owners understand how credit card chargebacks work, what to do when you have one and how to prevent them.
What are credit card chargebacks?
While credit card chargebacks are an important consumer protection to dispute a charge, they’re a big risk for business owners.
Credit card chargebacks occur for several reasons, including:
- The cardholder doesn’t recognize or didn’t authorize the charge
- The merchant accidentally charged the customer twice
- The customer never received the product or service, or the quality wasn’t as expected
When a chargeback happens, the bank withholds or withdraws funds from your merchant account and notifies you of the chargeback. You have a brief period to contest the chargeback — if you can provide evidence that the transaction was legitimate, the bank releases the money back to your merchant account.
However, if you don’t respond or don’t have sufficient proof that the transaction was legitimate, the funds will be returned to the customer, and you may have to pay an additional fee (typically ranging anywhere from $15 to $100).
Chargeback vs. refund
From your customer’s perspective, a chargeback and a refund are the same — in both situations, they get their money back. But from a business owner’s perspective, there are several key differences:
- A merchant initiates a refund. As a merchant, you can initiate a refund if the customer returns the product or isn’t happy with their service. Customers initiate chargebacks and can do so without letting you know they’re unhappy.
- Customers deal with the merchant directly for refunds. When a customer comes to you with a problem, you have a chance to replace a faulty product, perform a service again or provide other incentives to appease them before providing a refund. In a chargeback, the bank is the intermediary, so you normally don’t have a chance to make things right with the customer.
- Refunds cost less. Issuing a refund means you lose out on revenue from the sale, but you won’t have to pay additional fees or penalties or risk losing your merchant account.
Chargeback vs. voided transaction
Chargebacks are also different from voided transactions. A voided transaction is a transaction that never actually completes — while it might show up as a pending transaction for a short period, it’s canceled before it settles through the customer’s debit or credit card account.
Once the transaction is settled, you can no longer void it. To reverse the charge, you have to issue a refund or the customer has to initiate a chargeback.
How do chargebacks work? Time limits and rules
The good news for small businesses is that consumers have a limited time window in which to initiate a credit card chargeback — usually 60 to 120 days.
While each credit card processing company has its own procedure, the following is a rough sequence of events you can expect.
- Customer purchase. A customer makes a purchase in person, online or via an app and the business processes the credit card transaction.
- Customer files a dispute. The customer receives the product or service and isn’t happy with it or reviews their credit card transactions and notices a charge they didn’t authorize or don’t remember. The customer calls the bank to dispute the charge. The bank’s investigation usually starts with the transaction data they have on hand, such as timestamps, location data and IP addresses. This information can indicate whether the customer was involved in the transaction, or whether the transaction might have been fraudulent.
- Bank contacts the merchant. The bank contacts the merchant and asks them to provide evidence to refute the chargeback. The evidence you provide will depend on whether the transaction took place online or in person. If it took place in person, you should be able to show how the card-present transaction was processed. You may have to present confirmation or follow-up emails, automated invoices, shipping tracking details or another form of evidence for online or in-app purchases.
- Merchant accepts or disputes the chargeback. You have two options for handling the chargeback request. If you accept, the funds will be returned to the cardholder and the bank will still levy a chargeback fee. If you dispute it, the bank has anywhere from 10 to 90 days (depending on the type of transaction) to investigate the charge.
- Decision. If the bank notifies the customer that it concluded the transaction was legitimate, the customer can either accept the decision or continue to dispute it. The process of continuing the dispute is known as arbitration, and it involves the credit card company (Visa or MasterCard, for example) reviewing the documentation provided by both parties and making a final decision.
Chargeback fees are designed to cover the bank’s overhead for processing chargebacks. What you pay can vary depending on your history of chargebacks and your payment processor. If your business falls into the "normal" risk profile, meaning you have a chargeback ratio of less than 1%, the chargeback fee levied by banks or payment service providers usually ranges from $15 to $100. Having a higher chargeback ratio may increase your fee per chargeback.
The more chargebacks you get, the higher the fee. You could even be fined, face higher reserve requirements or lose your merchant account — the one you use to process credit card payments — if you have an excessive chargeback ratio. The definition of "excessive" can vary from bank to bank, but is usually anything greater than 1% or 1.5%.
Credit card chargeback merchant rights
Unfortunately, merchants don’t have many protections when it comes to fighting against chargebacks. Even if your store has a "no refund" policy, the Fair Credit Billing Act allows consumers to file chargebacks. Despite that, it’s a good idea to clearly display your refund policies and make consumers aware of your sales rules. This may become relevant if a chargeback ever goes through an arbitration process and generally helps with the above process of fighting against chargebacks.
By most accounts, banks tend to favor the cardholder over the business owner in most chargeback disputes. This is why merchants need to do everything in their power to have purchases and transactions well documented and in strict accordance with the rules set forth by the card networks.
Common chargeback reasons and how to prevent them
Any business that accepts credit cards has to deal with chargebacks from time to time. The best way to protect yourself and your business is by utilizing best practices on credit card use and payment processors.
The table below offers some best practices for preventing (or at least reducing) chargebacks stemming from different situations.
How to prevent chargebacks
|Legitimate fraud: A customer’s credit card is stolen, and the thief uses it to make fraudulent purchases.|
|Shipping or delivery issue: The customer didn’t receive the goods or services they purchased, shipping took longer than expected or the item arrived damaged.|
|Credit not processed: The customer informs the merchant that the product was returned or the transaction was canceled, but they haven’t yet received a refund.|
|Customer dissatisfaction: The customer received the product or service, but it was defective, damaged or not as described.|
|Unrecognizable business name: The customer doesn’t recognize the merchant’s business name on their credit card statement.|
|Failure to cancel subscription: While recurring subscriptions can be a valuable source of income, cardholders may forget about renewals and want to cancel after the fact.|
Friendly fraud is another source of credit card chargebacks. It occurs when a customer makes a legitimate purchase and then disputes the transaction with their credit card company, claiming that they didn’t initiate the transaction.
The term "friendly fraud" gets its name because the business owner may believe the customer is honestly a victim of legitimate fraud.
Many of the same strategies used to prevent other types of chargebacks can be used to prevent friendly fraud, including:
- Verifying that the customer’s billing address matches the address associated with their credit card
- Using shipping services that track delivery and require signature confirmation
- Analyzing sales records to identify customers who make chargeback requests regularly and considering not doing business with them anymore