What Is A Chargeback? Everything You Need To Know About Credit Card Chargeback Disputes

If you’re new to running a business or accepting credit card payments, you may not be very familiar with chargebacks. You also may not understand how to deal with them or fully appreciate how dramatically they can impact the success of your business.

For most merchants, chargebacks will be merely an occasional irritant, although the cost and time required to respond to them can still be significant. Some businesses, however, experience a far higher rate of chargebacks than others, and this can cause the cost of credit card processing to rise dramatically. In the worst-case scenario, excessive chargebacks can preclude you from being able to take credit card payments at all.

Whether you’re looking for a way to stem the rising tide of chargebacks that you’re experiencing or just want to know more about what they are and how they work, you’ve come to the right place. This article explains what chargebacks are and what you as a merchant will need to do when one is filed against your business. We’ll also explain the many ways in which chargebacks can cost you money, as well as reviewing how they work for payment methods other than credit cards. Finally, we’ll give you some tips on preventing chargebacks and dealing with them effectively when they happen anyway.

What Is A Chargeback?

A chargeback is a reversal of funds transferred between the customer’s credit card account and the merchant. Unlike refunds, the customer seeks to get their money back from their issuing bank, not the merchant. Once a chargeback has been filed, the merchant has the burden of proving that the customer’s claim is erroneous or fraudulent.

Chargeback policies have evolved over the years to protect consumers from unscrupulous merchants, so the entire process is heavily skewed in favor of the customer. This approach worked well for a long time, but in recent years, it’s increasingly been consumers who are behaving dishonestly. So-called “friendly fraud” — where customers deliberately file chargebacks against legitimate purchases to avoid paying for them — has become a significant problem.

There can be many acceptable reasons behind the chargeback, and each card association has its own list of reason codes for every possibility. In general, some of these reasons include:

• No authorization by the cardholder
• Goods/services returned or refused
• Goods/services canceled
• Goods/services not received
• Goods/services not as described
• Goods/services damaged or defective
• Canceled recurring billing
• Incorrect charge amount
• Duplicate charge

What Causes Chargebacks?

As you can see from the above listing of chargeback codes, there are many possible reasons why a chargeback might occur. Most of these reasons fall into one of the following three general categories:

• Merchant Error: Mistakes happen, and every once in a while, you’re going to make one. With so much of the sales process being automated today, inadvertent duplicate charges have become one of the most common causes of merchant errors. If you know you’ve made a mistake, we recommend against fighting this type of chargeback and saving your time and resources for incidents where you’re more certain that the customer made a mistake, not you.
• Customer Misunderstanding Or Dissatisfaction: With the rise in eCommerce in recent years, it’s fairly easy for customers to get confused if the name of your website doesn’t appear to match what shows up on their credit card statements. Customers can also bypass the normal return procedure and go straight to their issuing bank to get their money back, forcing you to have to deal with a chargeback.
• Fraud: Transactions that are outright fraudulent are, unfortunately, becoming more common as cybercriminals find new ways to exploit the chargeback resolution system. The fraudster might be either the actual customer (i.e., “friendly” fraud) or a third party that’s gotten access to credit card information through a data breach.

Who Can File A Chargeback?

In nearly all cases, chargebacks will be filed by the customer or someone acting on their behalf. Merchants generally don’t file chargebacks, although this might happen in the case of a B2B transaction.

The deadline to file a chargeback varies from one credit card association to another. Because chargebacks are primarily designed with consumer protection in mind, filing deadlines are very liberal. In general, customers have as long as six months after a transaction occurs to contest it via a chargeback. These lengthy deadlines are a product of the pre-internet era when consumers relied on a monthly paper statement from their issuing bank to sort out their purchases.

Who Investigates A Chargeback?

Chargeback dispute investigations involve no less than four parties: the customer, the merchant, the customer’s issuing bank, and the merchant’s credit card processor. While all of these parties have a say in the process, the issuing bank is responsible for conducting the investigation and making a final decision as to whether the transaction was legitimate or not. This can be somewhat confusing, as your credit card processor will usually charge you a fee when you incur a chargeback.

This fee is for your processor’s assistance in resolving the chargeback, and none of it goes to the issuing bank. You’ll usually have to pay this fee regardless of the final decision on the chargeback, although a few top-notch providers will refund your fee if you prevail.

How Do Chargebacks Work? Understanding The Chargeback Dispute Process

Chargeback dispute investigations follow a methodical process that’s defined by the various credit card associations. While each major credit card brand has its own specific rules and requirements, the general phases of a chargeback investigation are roughly the same for each of them. Here’s how it works:

The Chargeback Workflow

1. The cardholder initiates the chargeback process by contacting the issuing bank and giving a reason for wanting a refund or refusing to pay for a specific charge.
2. If the reason given fits within the allowed reasons for chargebacks, the issuing bank assigns a chargeback code to the incident and provisionally refunds the money to the cardholder. Then, the issuing bank contacts the acquiring bank to notify it of the chargeback claim and pull back the money already paid to the merchant.
3. Depending on whether the merchant has a direct or indirect relationship with the acquiring bank, either the acquiring bank or the merchant’s processor performs an investigation to see if there’s evidence at hand to refute the chargeback claim. If there isn’t, then they contact the merchant about the chargeback.
4. The merchant can elect to accept the chargeback or fight it. Either way, the merchant incurs a chargeback fee. If the merchant decides to fight the chargeback, then the merchant submits evidence to rebut the reason for the chargeback.
5. The evidence is passed back to the issuing bank, which then decides whether the chargeback is justified. If it is justified, then the cardholder gets to keep the provisionally returned money. If it’s not justified, the provisional refund is reversed and goes to the merchant (minus processing fees). However, the merchant does not receive a refund of the chargeback investigation fee unless the processor has a policy of allowing it.
6. If either the merchant or the credit card customer is not satisfied with the decision, they can escalate. Further action typically involves arbitration and costs a significant amount of time and money. For this reason, additional appeals are rarely pursued except in the case of very large transactions.

How Much Do Chargebacks Cost Merchants?

Whether you win or lose the investigation, a chargeback is going to cost you money. The costs of incurring a chargeback can include any of the following:

• Cost of the transaction in question
• Chargeback investigation fees
• Cost to replace lost inventory
• Time and money expended in fighting the chargeback

Note that you will incur many of these expenses regardless of whether or not you prevail in the chargeback investigation.

If your business experiences frequent chargebacks, it could potentially have a serious impact on your ability to continue accepting credit cards. Most credit card processors will take action against you if your chargeback ratio exceeds 1% of your transactions. This action might involve switching you to a high-risk merchant account with significantly higher processing rates and fees.

Some processors, however, will simply close your account altogether. To avoid having your account closed, it’s important to carefully monitor your account for chargebacks and take whatever proactive measures you can to lessen the possibility of experiencing an abnormally high number of chargebacks.

What Is a Chargeback Fee?

A chargeback fee is a fixed fee charged by your credit card processor for their assistance in investigating a chargeback reversal. What is a typical chargeback fee? They typically range between $15 and $25 per incident and are charged automatically whenever a chargeback is filed.

Most traditional merchant services providers will charge a chargeback fee regardless of the outcome of the investigation. However, a few top-rated providers (including Helcim and CDGcommerce) will refund the chargeback fee if the merchant prevails in the investigation and the chargeback is ruled invalid.

Are Chargeback Rules Different For Other Types Of Payment?

Until now, we’ve discussed chargeback rules and policies as they apply to credit card transactions. However, any payment method can be the subject of a chargeback if the customer wishes to pursue one. Here’s an overview of how chargebacks work with payment methods other than credit cards:

Debit Card Chargebacks

Customers have just as much of a legal right to file a chargeback when they pay with a debit card as they do when using a credit card. However, debit card transactions authenticated with the customer’s PIN are inherently much more secure than credit card transactions, making debit card chargebacks relatively rare. In most cases, it’s simply too difficult for a customer to prove that the transaction was fraudulent.

Many of the liability protections offered by credit cards don’t apply to debit card transactions. Under the Electronic Funds Transfer Act, a debit cardholder’s liability for fraudulent transactions is capped at $50 — but only if they report the loss of their card to their bank within two days of the loss. After that, cardholders are liable for up to $500 in fraudulent spending. After 60 days, all liability limitations are removed. The overall impact of these differences in the law is that merchants are much more likely to prevail in a debit card chargeback investigation.

ACH Chargebacks

ACH (Automated Clearing House) payments are similar to debit cards in that the money for a transaction is transferred directly from the customer’s bank account. However, no card is required — just the customer’s bank account and routing numbers. ACH transfers are inherently more secure and involve less risk, making them less expensive to process and less likely to be contested via a chargeback.

The rules for establishing a valid chargeback on an ACH payment are also more restrictive, making it more likely that the merchant will prevail in any investigation. The primary difference between credit card chargebacks and those involving ACH payments is that the customer has only 90 days from the date of the transaction (or 60 days from receipt of the customer’s monthly bank statement) to contest an ACH transaction. In contrast, credit card users have 120 days — or even longer — to file a chargeback.

While there are long lists of valid reasons for a chargeback on credit card transactions, ACH chargebacks will only be valid for the following reasons:

• The transaction was never authorized, or the authorization was revoked
• The transaction was processed on a date earlier than authorized
• The transaction is for an amount different than what was authorized

Digital Wallet Chargebacks

As the banking industry transitions to a fully digital process of making payments and transferring funds, new payment methods, such as PayPal, Zelle, and Venmo, have been introduced and are becoming increasingly popular with consumers. As a very general principle, the rules for processing a chargeback when one of these payment methods is used will depend on the type of account used to fund the transaction.

For example, if a customer uses their PayPal account, which is linked to their checking account, the rules for ACH chargebacks will apply. Likewise, a customer using Venmo and linking their account to their credit card will have to follow the rules for credit card chargebacks. Note that this situation may change in the future as the industry develops rules and policies that apply specifically to these payment methods.

What Can You Do About Chargebacks?

With merchants usually losing four out of five contested chargeback investigations, it may seem to you that they’re just an inevitable cost of doing business. In reality, however, there is a lot you can do to lessen the overall impact chargebacks have on the financial health of your business.

Your primary strategy should be to prevent chargebacks from occurring in the first place, with a secondary emphasis on being ready to challenge the chargebacks that do occasionally happen. We recommend a three-pronged approach:

1. Establish fair, transparent refund policies that encourage customers to work with you directly rather than resorting to filing a chargeback.
2. Maintain meticulous records, including clear, legible copies of receipts that can be used to prove that a transaction was legitimate if a chargeback occurs.
3. Consider enrolling in your merchant account provider’s chargeback prevention program, if one is offered.

For more details on how to implement these strategies and additional tips for dealing with chargebacks, please check out these articles:

• The Small Business Guide To Preventing Chargebacks (& How To Fight Chargebacks When They Happen)
• The Complete Guide To Chargeback Protections & Management For Merchants

Why Small Businesses Get Hit With A Chargeback Fee Per Incident

A chargeback fee is considered a markup fee. That means the fee is charged directly by your merchant account provider rather than being passed on to the cardholder’s issuing bank like interchange fees. Like other markup fees, you can negotiate the amount of this fee when setting up your merchant account. However, don’t expect to eliminate it altogether.

Chargeback fees typically cost $15-$25 per incident. If your business never experiences a chargeback, you’ll never have to pay this fee. However, nearly all businesses get hit with a chargeback every once in a while. You will usually have to pay the full amount of the chargeback fee regardless of the outcome of the investigation. This fee compensates your provider for the additional time and effort on their part to assist you with investigating the chargeback.

The Bottom Line On Credit Card Chargebacks

If you take credit cards, you will have to deal with chargebacks sooner or later. While you can lower the frequency of chargebacks by pursuing an effective strategy to prevent them, you’re bound to experience one eventually. This is especially true with the dramatic rise in “friendly” fraud incidents in recent years.

At the same time, having too many chargebacks (i.e., more than 1% of total transactions) is cause for concern. While unlikely, an excessive number of chargebacks could potentially destroy your business. Your provider might switch you to a much more expensive, high-risk merchant account or impose a rolling reserve that can put a serious crimp in your cash flow. In a worst-case scenario, your provider could close your account altogether and put you on the dreaded MATCH list. Once this happens, it will be very difficult for you to get approved for a new merchant account with another processor for five years.

Whenever possible, encourage your customers to contact you directly for a refund, rather than calling their bank for a chargeback. Be friendly and accommodating. Hopefully, you can resolve the issue directly and avoid the hassle and expense of dealing with a chargeback.

If you have questions or interesting stories about chargebacks, leave us a comment below. We’d love to hear from you.

Frequently Asked Questions About Chargebacks