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A Beginner’s Guide to Credit Card Chargebacks

What Is a Chargeback?

Chargebacks—also known as reversals—occur when funds are returned to the purchaser in a transaction, and they usually involve card-not-present (CNP) credit card transactions. At their base level, they are a consumer-protection mechanism enabled under Regulation Z of the Truth and Lending Act . Side note: Debit cardholders are afforded the same rights under Regulation E of the Electronic Fund Transfer Act.

A chargeback is not a refund. A refund is a voluntary reimbursement that merchants give to customers. Chargebacks, on the other hand, are disputes initiated by the purchaser through their issuing bank (i.e., the bank that issues the credit card) and are forced. In the case of refunds, the purchaser gets money back from the merchant. For chargebacks, however, the issuing bank refunds the money to the purchaser and then pursues the merchant for reimbursement.

The customer gets their money back, usually within ten days, and the issuing bank opens a chargeback dispute with the merchant. In most disputes—regardless of the outcome—merchants will have to pay a chargeback fee to compensate the credit card processor for investigating the claim. 

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When Do Customers Request Chargebacks?

Many chargebacks result from legitimate criminal fraud. Bad people steal credit card numbers and use them to purchase goods and services. It’s likely happened to you—you check your credit card statement only to notice a $200 charge from a makeup store in Boise when (a) you’ve never been to Idaho and (b) you don’t wear makeup. Some other situations that result in chargebacks:

Accidental fraud

This kind of fraud happens when a customer makes a purchase but doesn’t recognize the merchant’s name on the bank statement. Issuing banks are usually good at screening for this kind of “fraud” and help cardholders recognize charges—but not always.

Friendly fraud

This type of chargeback occurs when customers make a legitimate purchase, receive the goods, and then dispute the charge. These fraudsters abuse merchants’ policies to keep products instead of returning them. It’s a huge problem: by some estimates, friendly fraud is expected to account for 61% of all chargebacks in North America by 2023.

Legitimate disputes

In many cases, customers trigger legitimate disputes if they have trouble with a merchant’s products or services. Examples include the following:

  • Duplicate charges
  • Misplaced orders and processing/shipping errors
  • Damaged items
  • Cancelled subscriptions (a customer cancels a subscription but is charged anyway)

Accordingly, if you want to minimize chargebacks, you need to get serious about fraud prevention. Some possibilities include verifying the customer’s billing address, tracking shipments and requiring a signature upon delivery, and monitoring and banning customers with a penchant for initiating chargebacks.

If you’re looking for ways to prevent chargebacks, Sekure has another post on that topic.

What Is the Chargeback Process?

Here is an overview of how chargebacks are handled:

  1.     The customer—usually after seeing an unusual or unrecognized charge on their credit card statement—contacts the issuing bank to make a chargeback claim.
  2.     If the request is justified, the issuing bank assigns a code to the claim and refunds the cardholder. Claims are sometimes denied, but in most cases, they are accepted. (Chargebacks are a consumer-protection mechanism, after all.)
  3.     The issuing bank notifies the acquiring bank (the bank that processes payments on behalf of the merchant) of the claim.
  4.     The merchant’s acquiring bank reviews the file and either resolves it or contacts the merchant.
  5.     If the chargeback is forwarded to the merchant, the latter can either accept it or dispute it. Should the merchant decide to fight the chargeback, it must submit proof that the customer’s purchase was legitimate. Important point: regardless of whether the merchant accepts or fights the chargeback, they will usually have to pay a chargeback fee.
  6.     The merchant’s acquiring bank presents the case to the consumer’s issuing bank. If the issuing bank accepts the merchant’s case, the funds are returned to the merchant, and the charge on the consumer’s card will be upheld. Should the issuing bank agree with the consumer’s case, the latter will keep the forced refund.

Chargeback Consequences

As you can see, processing chargebacks is a cumbersome procedure that involves many participants and interactions. Not surprisingly, chargebacks are costly for businesses. As you just learned, even if you challenge a chargeback and win, you will most likely have to pay the chargeback fee. Therefore, merchants need to do everything in their power to avoid chargebacks in the first place. Here are some direct and indirect costs associated with chargebacks:

  • Opportunity cost
  • Cost of the forced refund
  • Lost inventory
  • Time and money
  • Shipping costs
  • Chargeback fees
  • Brand loyalty
  • Increased transaction fees (including possible credit card penalties)

In addition to these costs, merchants with exceedingly high chargeback rates can even have their merchant accounts shuttered.

As for chargeback fees, they depend on your chargeback history and your payment process and can range from $15 to $100. It’s worth noting that merchants that get more chargebacks tend to pay higher fees.

A term you should be aware of is a chargeback ratio—the number of chargebacks received in a month divided by the total number of monthly translations. For instance, if you process 500 transactions per month and have 25 chargebacks, your ratio would be 0.5%. Keeping your chargeback ratio under 1% is advisable; failure to do so could result in higher chargeback fees and even monthly fines.

Finally, even if you win a chargeback dispute, it still counts as a chargeback for the purposes of determining your chargeback ratio. Your best bet: stop chargebacks from happening in the first place.  

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Chargebacks: Merchant Rights

Although chargebacks were developed as a consumer-protection mechanism, merchants have some recourse to fight chargebacks. That said, banks usually side with the consumer in the majority of chargeback disputes. Here are a few rights afforded to merchants:

Late delivery returns: Customers who dispute transactions due to late deliveries must attempt to return the product before they can initiate a chargeback.

Representment: The process whereby merchants submit proof that a chargeback is illegitimate.

Arbitration: This is usually the last stage of any dispute and generally doesn’t go well for the merchant. Arbitration usually occurs when a merchant’s representation is successful. It can be an expensive process and is rarely worth pursuing. 

Conclusion

That’s an overview of chargebacks. Managing chargebacks is a costly and time-consuming business. One of the ways merchants can avoid chargeback is to sekure a payment processing system that makes it easier to keep accurate records. Another way to avoid chargebacks is to resolve the matter with the cardholder to avoid escalation.  However, chargebacks will always be a part of business, so merchants should understand the process to minimize chargeback risk—which will only continue increasing as eCommerce grows. If you’ve got questions about chargebacks, or anything payments-related for that matter, get in touch with one of Sekure’s payment professionals, and they’ll be happy to help you out.

Tom Haney

Tom Haney

Tom Haney is a writer, translator, and editor. In addition to toiling in the communication field, he also works in the forest on his side-hustle, Sweetbark maple syrup. He lives in Centretown with his wife, daughter, and pooch, Louie.

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