According to a 2021 credit card fraud report from the Security.org team, at least 58% of Americans experienced a fraudulent credit card charge at some point in their lives, with 69% stating it was during the last two years. These numbers are alarming not only for customers but also for merchants. That’s because customers experiencing a fraudulent charge will contact their bank for refunds, which will lead to a chargeback.
Chargebacks are a significant problem for merchants, as they not only represent a loss in revenue but also lead to other more drastic problems. As such, it becomes essential for merchants to understand all aspects of this process to deal with them or reduce their occurrence properly.
In this guide, you will find everything about chargebacks and their importance for merchants, including how they work, the different types, their effects, and tips on dealing with them.
What Is a Chargeback?
When looked at in the most simple terms, a chargeback is the reversal of a payment made with a credit or debit card by an issuing bank due to a fraudulent transaction.
However, a chargeback is more than a single event; it’s more of a process that involves an investigation by the issuing bank, a dispute process by the merchant, and the submission of evidence by the customer, the acquirer bank, and the merchant.
Chargebacks are meant to protect consumers from fraud and are naturally weighed against merchants. To further complicate matters, each bank and card network has chargeback guidelines.
Furthermore, chargebacks have significantly damaging consequences for merchants beyond the payment reversal, such as fees, fines, and in extreme cases, even account terminations.
Debit vs. Credit Card Chargebacks
From a merchant’s perspective, there aren’t many differences between credit and debit card chargebacks, as most of them are on the customer’s side of things.
For starters, customers have more leeway regarding liability and time limits for disputes filed against credit card charges. Credit cards generally have a liability cap of $50, with some banks offering cards with full refund benefits for fraud.
That same $50 cap applies to debit cards if they file a dispute within two days. If done after two days but before 60, the cap goes up to $500. And if they want to file after that, there is no liability limit.
Refunds for credit card disputes are also much faster, given that credit cards use funds belonging to the bank, while debit cards require a cash transaction to restore the funds. A debit card chargeback has a 10-day timeline for refunds, while credit cards usually receive a provisional credit within 1-2 business days.
As far as merchants are concerned, a debit card chargeback would be better than a credit card one due to the increased liability and stringent time limits that a customer has for filing a dispute. However, once a dispute has turned into a chargeback, a merchant will deal with it the same way regardless of if it was for a debit or credit card charge.
Another type of chargeback that is far less common is the bank chargeback, which differs from a customer chargeback in that it is initiated by the bank when they detect an anomaly with a transaction. These chargebacks are traditionally resolved between the issuing bank and the acquiring bank, and traditionally neither customers nor merchants are aware of them until the bank’s investigation is resolved.
Refund vs. Chargeback
While both involve the return of the money spent by the customer, chargebacks and refunds have two critical differences:
- In a refund, the customer must return the goods to receive their money. With chargebacks, the bank returns the money to the customer, regardless of the status of the goods, meaning that the merchant loses the value of the merchandise on top of the sale.
- Refunds have a dramatically smaller impact on merchants than chargebacks. Refunds might come with additional fees, but chargebacks have larger fees and penalties. These can include fines, account holds, and even termination.
Who is Responsible for Chargebacks?
While both the customer and the merchant are responsible for chargebacks, it is mostly the merchant that bears the weight of the issue once a dispute is filed. Furthermore, the dispute process asks more from the merchant in terms of evidence than it does from the customer.
As such, the responsibility of reducing the risk of chargebacks often falls to the merchant, as they have the most to lose when chargebacks are filed.
The Chargeback Process: Relevant Parties and Steps
There are two elements to the chargeback process: the players involved in it, their roles, and the steps they must go through. Here’s a look at both:
The Parties Involved in a Chargeback Process
While it may seem like chargebacks only involve three players (the cardholder, the bank, and the merchant), they can have five participants.
The parties involved in a chargeback are:
- The cardholder: The owner of the card used to make the transaction and under which the dispute is filed.
- The merchant: The company that sold the goods or services for which the chargeback is filed.
- The issuing bank: The bank that issued the cardholder’s card.
- The acquiring bank: The bank of the merchant.
- The credit card network: The card association that owns the card brand used for the transaction. They, along with the issuing banks, set the terms and guidelines for transactions and disputes.
In some cases, parties could become involved, such as payment processors or gateways.
The Steps of the Chargeback Process
The chargeback process can be divided into six steps, which are as follows:
- The cardholder contacts their bank to dispute a charge as unauthorized or fraudulent and asks for a refund, starting the chargeback process.
- The bank reviews the initial claim and assigns a reason code to the case. If the claim is valid, the bank proceeds with its investigation and moves to step 3.
- Funds are removed from the merchant’s acquirer bank account and credited to the cardholder, usually reflected as a provisional credit on their account. The acquiring bank, in turn, takes the funds from the merchant.
- The issuing bank notifies the acquiring bank of the chargeback. If the acquiring bank has any supporting evidence, they provide it directly. Otherwise, the merchant is notified of the issue.
- If the merchant believes the claim to be invalid, they can start a dispute process, where they submit their evidence and a rebuttal letter to support the legitimacy of the charge.
- The issuing bank reviews all the evidence and comes to a decision. If the claim is valid, the provisional credit is made permanent. If not, the funds previously taken from the merchant are returned. Any chargeback fees will remain, however.
If the merchant refuses to accept the issuing bank’s final decision, they can move into arbitration. If they win, it can be beneficial to them. However, should they lose, this would come with significant fees. It should be noted that arbitration is traditionally difficult for merchants to win.
How Long Do Chargebacks Take to Process? Do They Have Time Limits?
Chargebacks can take anywhere from 30 to 90 days to process, depending on various factors that include the reason for the chargeback and the process used by the cardholder’s bank and card network.
There are also time limits for customers and merchants when it comes to filing a claim or disputing a chargeback.
While the Fair Credit Billing Act of 1974 (FCBA) gives cardholders a minimum of 60 days to file a claim, banks and card networks are allowed to set guidelines so long as they don’t run afoul of the FCBA’s limits, which applies to customers and merchants.
Most banks and card networks give cardholders up to 120 days to file a dispute. On the other hand, merchants have 20 days per phase for chargebacks from American Express, 30 days for Visa and Discover, and 45 days for Mastercard.
However, these time limits are shared by merchants and acquirers, which usually leads to acquirers moving deadlines ahead to give themselves more time.
Furthermore, merchants are not always notified right as this timer starts. In some cases, it may take between 2 to 3 days for merchants to become aware of the chargeback, further lowering their response time limits.
What Are the Reasons for Chargebacks
While card networks and banks have different codes that they use to specify the reason for a chargeback, all chargebacks can ultimately be grouped into one of three reasons:
- Merchant error: mistakes on the merchant’s side that lead to an issue with the transaction.
- The merchant sent the wrong product or oversold it.
- The customer canceled a subscription but the merchant still charged once more due to an error.
- Criminal fraud: deliberate actions taken by a third party to steal from the consumer or the merchant. In some cases, this could be fraud from the merchant itself.
- A third party steals a card and uses it to make purchases.
- A third party gains access to the cardholder’s bank details and uses them to transfer funds to themselves.
- The merchant doesn’t ship a product after payment is made.
- The merchant sells a knock-off product as authentic.
- Friendly fraud: fraudulent claims made by the customer, unintentionally or otherwise.
- The customer forgets about a purchase and files a chargeback.
- One person in a couple reverses a charge on their shared account due to unawareness.
- The customer claims they never received the goods, which they did.
As mentioned before, card networks and banks have their own chargeback codes that they use when issuing a chargeback to help identify the reason and make the process simpler and more specific.
The Problems with Chargebacks for Merchants
Chargebacks present a lot of problems for merchants, both in the short and long term. While the revenue loss from chargebacks is troublesome, the long-term consequences present a substantial problem.
These are the consequences that chargebacks can bring for merchants:
- Chargeback fees: merchants must pay a fee to cover the administrative costs of chargebacks for their acquirer bank each time one is filed, regardless of the results of a dispute. These fees can range from $20 to $100 per transaction. These are the consequences that chargebacks can bring for merchants:
- Lost merchandise and other charges: if the merchandise is not returned, which is the majority of the time for fraud disputes, the customer loses its value on top of the sales revenue and any associated fees like shipping charges.
- Fines and penalties: card networks and banks have chargeback thresholds for merchants. If a merchant exceeds this threshold, they might accrue fees or penalties such as account holds or additional oversight.
- Account termination: if the chargeback rates remain above the acceptable threshold, the merchant’s account can be terminated. If that happens, the merchant will be placed on Mastercard’s Member Alert to Control High-Risk Merchants (MATCH) list, a database managed by Mastercard that keeps track of businesses that have had their accounts terminated by their acquirer banks, which acts as a blacklist of sorts and severely limits the options of a business in terms of opening a new merchant account.
The Chargeback Threshold
A chargeback rate or threshold is the ratio between the total number of chargebacks a merchant receives against their total number of transactions, normally calculated monthly.
For example, if your business had 50 chargebacks cases and 5,000 transactions in a month, your ratio would be 1% (50/5000 = 0.01 = 1% ratio).
Card networks might have slight differences in how they calculate your chargeback rate. For instance, Visa uses the transactions and chargebacks of the current month, while Mastercard uses the previous month’s transactions instead.
They also have standards for an acceptable chargeback rate and an excessive chargeback threshold.
Visa has a standard threshold of 0.9% of your monthly transactions, with the excessive threshold being 1.8%. However, they have an early warning system that triggers at 0.65%.
Mastercard, on the other hand, uses a flat amount of chargebacks and a ratio for their “Monitored Merchant” status. Their excessive chargeback threshold is 100 chargebacks per month with a 1.5% ratio for at least two consecutive months. The threshold is 100 chargebacks per month with a ratio of at least 1%.
Furthermore, since chargebacks affect a merchant’s acquirer bank, they might have their own rules regarding handling them.
How Can Merchants Dispute Chargebacks?
As previously mentioned, merchants can dispute chargebacks during the investigation stage through a process called chargeback representment.
For the representment process, the merchant has two main requirements, which are:
- Writing a chargeback rebuttal letter.
A rebuttal letter is a brief statement that states the merchant’s case. It should use short sentences, persuasive language, and bullet points to highlight its points.
Some of the elements that it should include are:
- The reason code for the chargeback.
- The amount being contested in dollars.
- A summary of the evidence presented.
- Submitting supporting evidence.
The merchant must provide any evidence that they have that supports the legitimacy of the charge. The evidence you should submit will vary depending on the reason for the chargeback, but some examples include:
- Delivery and sales receipts.
- The cardholder’s transaction history.
- Any written communication between the merchant and the cardholder.
- Delivery and tracking verification.
- Photo evidence.
The merchant’s evidence is passed along to the issuer by the acquirer.
The chargeback will remain if the issuing bank doesn’t find the evidence sufficient. At that point, the merchant can request arbitration from the card network. They would follow a similar process of submitting evidence, only this time to the card network.
How Can Merchants Prevent Chargebacks?
Since chargebacks mostly happen due to customer issues, it’s in the merchant’s best interest to combat the issues that bring them about in the first place.
Issues with transparency, customer satisfaction, or fraud are the leading causes of chargebacks.
You’ll want to be fully transparent with your customer about all fees involved in their purchases and immediately tackle any issues they bring to you. If they are not satisfied, make them aware of your refund process and make it simple for them to follow.
As for the fraud aspect, make sure to use all the tools available to combat fraud, such as tools that automate responses to red flags in the purchase process.
While chargebacks pose a significant issue for merchants, they are not without recourse for dealing with them. The best thing to do is inform yourself of the process followed by the bank and the limits for disputing the charge based on the reason code provided. Gather all the necessary evidence and write a rebuttal letter that successfully conveys your side of things to support your case.
However, the best way to deal with chargebacks is by trying to prevent them in the first place. As such, merchants should remain ever vigilant about their fraud prevention tools and customer service, which will allow them to handle any customer complaint promptly.