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What Is A Chargeback?: A Guide To How It Works And How It Affects Your Business

Responding to disputes can be aggravating for businesses. This is particularly true in the case of chargebacks. Businesses risk losing money when customers file a dispute with a financial institution rather than resolving the issue or receiving a refund directly from merchants.

To avoid frequent chargebacks and related merchant account service fees, it's critical to understand how these disputes work and what you can do to counter them.

Contents

The Definition of Chargebacks

A chargeback, also known as a payment dispute, occurs when a cardholder disputes a transaction and requests that it is reversed by the card's issuing bank. While the opportunity to dispute a payment is intended to protect consumers from fraudulent transactions, it may cause significant issues for businesses, particularly when payments are given in error.

When a chargeback occurs, the firm is held responsible for the disputed cash until the card issuer resolves the dispute and determines a course of action. If the bank rules against you, the cardholder receives the cash back. If the bank determines in your favor, they will refund you for the disputed cash. 

Chargebacks vs. Voided Charges

It's important to note that a chargeback is not the same as a voided transaction, which is also known as a voided charge. When a charge is repudiated, the transaction is canceled before it has the opportunity to be settled with the customer's debit or credit card account.

The Most Common Causes of Chargebacks

What Is A Chargeback?: A Guide To How It Works And How It Affects Your Business

Legitimate Fraud

If a cardholder notices a charge from your business but has never made a purchase from you, this could indicate fraud. This frequently results in their filing a dispute. Chargebacks can be used to report legitimate fraud in some instances. They serve their intended purpose when they provide clients with a quick and easy way to report fraudulent transactions on their credit card statement.

To avoid this type of conflict, accept chip cards and contactless payments using a secure point of sale (POS). You may also encourage buyers who use EMV (chip cards) to dip rather than swipe their cards.

Friendly Fraud

Because some consumers abuse the chargeback procedure, friendly fraud is frequently referred to as chargeback fraud. This issue involves customers who purposefully defraud retailers by alleging that lawful purchases are fraudulent.

However, a client may initiate a chargeback for a variety of sufficiently reasonable issues even if the charge is technically valid. These instances still fall under friendly fraud since they violate the underlying principles of chargebacks as a consumer protection measure. The following items on this list are some chargeback examples that could be considered friendly fraud.

Return Process Avoidance

A consumer may choose to bypass the return process in favor of filing a chargeback to obtain payment for the disputed transaction. This typically happens when the return process is very complicated or when the time specified in the return policy has expired.

This can be avoided by establishing a clear return policy. Returns can be somewhat costly, and not everything you receive back is resalable. To mitigate its income impact, you must maintain precise records that allow you to quantify the financial implications of your return policy.

Delivery, Shipping, And Pricing Issues

If there is a problem with an order’s delivery, the client may request a chargeback (for example, if the order was never delivered). Similarly, if a consumer believes they were overcharged for an order, charged the incorrect price, or charged twice the cost, they may initiate a chargeback with their credit card issuer.

Unauthorized Credit

In this circumstance, the cardholder returns an item with the expectation of receiving a refund or account credit but receives neither. The reason for the return could be buyer's remorse or an error committed by the consumer following an online purchase.

To avoid this problem, ensure that your return and credit system is reliable and that your sales policies — such as your return, refund, or cancellation policies — are clearly written on your receipts and widely posted throughout your firm.

Failure To Cancel Subscriptions

While the option to set up regular payments for subscriptions benefits both businesses and cardholders, it also increases the possibility of a dispute. This is because cardholders regularly overlook subscription renewals and file disputes with their credit card company in order to get the money refunded.

If you wish to establish a regular billing period, ensure that cardholders are informed of the recurring transaction (RT) agreement provisions. If feasible, present them with a visible indicator of their comprehension and agreement, such as a checkbox or signature.

Dissatisfaction With A Product Or Service

If a customer is displeased with the goods or services they received, they may choose to file a chargeback rather than settle the issue with the vendor. When it comes to products, this is often due to physical flaws or an item failing to live up to expectations. When it comes to services, quality is more subjective and difficult to quantify.

That said, consumers have the right to file a claim if they get a damaged or defective item. This chargeback scenario may also fall under the category of "return process avoidance."

The Chargeback Process

The chargeback procedure is fairly straightforward and typically proceeds as follows:

  1. A purchase is made using a credit card from your business.
  2. The transaction is completed, and you are refunded by your payment processing firm.
  3. The customer notices the transaction and initiates a chargeback with their credit card company.
  4. The chargeback process is initiated by the issuing bank.
  5. The issuing bank contacts your bank — the merchant bank — and requests any documents necessary to challenge the chargeback. If your bank does not reply to the chargeback notification, the issuing bank normally grants the customer's dispute and withdraws the money from your account, reimbursing the customer.
  6. The issuing bank makes a decision. If documentation is produced to contest the chargeback, the issuing bank must next analyze the evidence and decide regarding the validity of the chargeback.
    • Funds are returned to the consumer. Once again, if the issuing bank takes the customer's side, the issuing bank will debit your account and credit the customer.
    • On the other hand, if the bank sides with you — the merchant — the consumer is informed and given the option of paying the fee or initiating an arbitration process. Arbitration refers to the chargeback dispute to the credit card issuer, which reviews the occurrence and renders a final judgment.

How To Avoid Future Chargebacks

Chargebacks are a nuisance to small businesses, whether they are the result of legal or friendly fraud. Adhere to credit card acceptance criteria and industry standards. You can avoid chargebacks by adhering to credit card guidelines, maintaining PCI compliance, and utilizing all available tools to combat legitimate fraud.

To avoid friendly fraud, create transparent corporate policies and place a premium on customer service. Establish clear and transparent business standards — particularly those about shipping and returns.

Finally, go for reputable merchant account providers to ensure security. Merchant account providers act as intermediaries between merchants and card issuers. They will offer you the tools necessary to accept and process card-based payments and assist you in the event of disputes.

Frequently Asked Questions

Why is a chargeback bad? 

Chargebacks are bad for businesses due to the fees associated with them, which can range from $20 to $100. Businesses with a lot of chargebacks run the risk of their account being shut down. 

Do chargebacks hurt credit scores?  

Filing chargebacks typically do not affect one’s credit. An issuer may add a dispute notation to your credit report, but this won’t have a negative effect on your credit. 

How do you win a chargeback dispute as a merchant? 

Merchants must have evidence that persuades the cardholder’s bank to reevaluate the dispute. Such evidence needs to prove that a merchant has identified who the shopper is and that the transaction was processed correctly. 

Is a chargeback an expense?

Chargeback fees should be classified as part of a business’s operating expenses. 

Can a customer cancel a chargeback?

Customers typically have 10 days to cancel a chargeback after it has been issued. Chargebacks can be canceled by contacting the bank or payment provider. 
Because chargebacks can have a negative impact on your business, it's ideal to arm yourself with a complete understanding of the chargeback process. Additionally, a high chargeback rate erodes your merchant credibility.

If you're unsure whether your chargeback rate is acceptable or not, take a look at the average dispute rates for merchants on Processing Card.

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