What are Credit Card Chargebacks?
How a Credit Card Chargeback Affects the Merchant
Any cardholder who uses a payment card (credit, debit or prepaid) has the right to utilize the consumer protection mechanism known as the chargeback. Both consumers and merchants should be aware of the conditions that apply to using this consumer protection, including the difference between debit and credit card chargebacks, when disputes can legally be filed, and how chargebacks affect the merchant.
The Truth in Lending Act of 1968 laid the groundwork for credit card chargebacks. However, payment industry experts recognize The Fair Credit Billing Act of 1974 as the invention of chargebacks. Debit card holders were awarded reversal rights courtesy of Jimmy Carter’s 1978 Electronic Fund Transfer Act.
Chargebacks were designed to protect consumers from two types of fraud associated with credit or debit card transactions.
1. Criminal Fraud
Cardholders aren’t expected to pay the bill for unauthorized transactions placed by hackers or other thieves. Examples of such fraud include:
- Criminals make a duplicate copy of a credit card and use the counterfeit card to make transactions at brick-and-mortar establishments.
- Hackers access credit card information and use it to place unauthorized transactions in card-not-present situations (ecommerce, mcommerce, telephone orders or mail orders).
- Thieves steal a credit card and use it to make either card-present or card-not-present purchases.
2. Merchant Fraud
If an unscrupulous merchant commits fraud, the cardholder can be reimbursed. Examples of such fraud include:
- A merchant intentionally process a transaction more than once.
- A merchant doesn’t disclose important information like the return policy or the use of dynamic currency conversion.
- A merchant raises the price of a recurring transaction without notifying the cardholder.
- A merchant intentionally sells poor quality items or services, dishonestly hypes the product’s abilities, or sells counterfeit items.
- A merchant doesn’t issue a credit for returned merchandise.
- A merchant doesn’t deliver the products or services.
Filing a Chargeback
Cardholders instigate the chargeback process when they contact the bank for a forced credit card refund. The bank will review the claim and if substantiated, the original transaction amount will be withdrawn from the merchant’s account and credited to the cardholder’s account.
Each chargeback is accompanied by a reason code, which helps the merchant discern what went wrong with the original transaction. If the merchant feels the chargeback has been filed in error or is a case of friendly fraud, the merchant can dispute the chargeback with a process called representment.
If the merchant successfully disputes the chargeback, the original transaction will be applied to the cardholder’s account a second time. If the merchant is forced to accept the chargeback, the business will lose the money earned from the original transaction and pay the accompanying chargeback fee.
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Putting Chargebacks into Practice
Chargebacks can only legally be used in the above mentioned situations of criminal or merchant fraud. And even if fraud has occurred, it is in the best interest of the consumer to communicate directly with the merchant.
Sometimes, the perceived fraud might actually be an accident. Perhaps the consumer has forgotten about the purchase or the merchant made an innocent mistake. Plus, a refund usually puts money back in the consumer’s account much quicker than a chargeback.
Because it is beneficial for both merchants and consumers to resolve transaction disputes without the use of a chargeback, merchants need to ensure they are providing exceptional customer service that adequately addresses the consumer’s grievances.
If chargebacks are used in any other situation, the consumer is engaging in friendly fraud. Friendly fraud is regularly referred to as chargeback fraud because the consumer uses the chargeback process to deceitfully obtain a refund.
Some examples of friendly fraud include:
- Filing a chargeback because it is less stressful than obtaining a refund from the merchant.
- Using a chargeback to cancel a recurring transaction rather than deal with the merchant directly.
- Intentionally filing a chargeback to get something for free.
The Difference between Debit and Credit Card Chargebacks
While consumers might not perceive a huge difference between a debit and credit card, the chargeback protection for the two cards varies greatly.
For a detailed explanation, check our blog article explaining chargeback debit card transactions.
Basically, a debit card doesn’t offer the same level of protection as a credit card.
|Credit Card||Debit Card||Prepaid Card|
|Fraud Protection||Cardholder liability is capped at $50.||If reported within two days, liability is capped at $50. If reported after two days, liability is capped at $500. If reported after 60 days, the cardholder is liable for the entire transaction amount.||Liability is determined at the discretion of the issuer. At best, protection will mimic a debit card.|
|Refund time frame||Accounts are usually reimbursed immediate or within a few days.||It might take 10 days for the bank to award a refund.||The time limit is also at the discretion of the issuer, but usually is within 10 days.|
Because of the decreased protection, debit card chargebacks aren’t as common as credit card chargebacks. However, they both affect the merchant the same: revenue is lost and fees are assessed.
The Consequences of Credit Card Chargebacks
Both merchants and consumers are penalized with each credit card chargeback filed.
Consequences for Merchants
Chargebacks affect a merchant in the following ways:
- Each chargeback comes with a fee, usually between $20 and $100 each.
- If the consumer files a chargeback instead of returning the merchandise for a refund, the merchant isn’t able to earn any revenue by selling the products to someone else.
- Each chargeback filed negatively affects the merchant’s chargeback rate. Banks carefully monitor a merchant’s perceived level of risk; the more chargebacks sustained, the higher the risk.
- If the bank feels the merchant is receiving too many chargebacks, the bank will require a merchant account reserve. Funds will be held to cover any future losses. This creates cash flow issues for the merchant.
- A merchant who suffers from excessive chargebacks will be punished even more severely. The bank could discontinue the merchant’s ability to process credit card payments.
- If the merchant’s bank account is closed, the business has two options: wait five years until the merchant is removed from the MATCH list and can obtain a new merchant account or look for a high risk payment processor. Being labeled a high risk merchant means the business will have to pay additional processing fees and higher chargeback fines.
Consequences for Consumers
The chargeback repercussions for the merchant are quite obvious. While less noticeable, there are consequences for the cardholder too.
- To compensate for inevitable chargeback fees, merchants are forced to raise their prices.
- The cardholder might be expected to pay the chargeback fees if a transaction dispute isn’t found in the consumer’s favor.
- If the cardholder’s bank suspects a case of chargeback fraud, the credit card account could be closed. This would negatively affect the consumer’s credit score.
The Importance of Prevention
Ultimately, if a merchant engages in chargeback prevention practices, both the business and the consumer will benefit.
- The consumer will have a better shopping experience and the chance of friendly fraud is decreased.
- The merchant retains more profits and avoids unnecessary chargeback fees.
The suggestions found in our eBook will greatly reduce the risk of credit card chargebacks. However, chargeback prevention isn’t a one-size-fits-all approach. As risks and threats adapt, a merchant’s prevention strategies need to evolve too.
If you’d like help creating a customized chargeback prevention strategy, let us know. Chargebacks911™ can also help you fight chargebacks, recouping profits that never should have been lost in the first place. Contact us today and we’ll provide a free chargeback analysis with an ROI quote.
As customers and merchants come to understand the chargeback etiquette, the need for credit card chargebacks will decrease and the ecommerce environment will be more enjoyable for everyone involved.
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