Everything You Need to Know About Chargebacks

While the advent of card-not-present transactions has revolutionized business across the globe, chargebacks are, by far, one of the biggest negative consequences of this type of payment.

Here’s what every business needs to know about chargebacks.

What are Chargebacks?

Chargebacks are the reversal of credit card charges through a bank. Unlike refunds or order cancellations, which are mutually agreed upon by the customer and the merchant in question, a chargeback involves a customer disputing a charge with their bank.

As part of this process, the bank has to review chargeback requests to make sure that the request is legitimate. However, the bank rules in the consumer’s favor more often than not and will forcibly withdraw the money from the merchant’s bank account.

Benefits of Chargebacks

Chargebacks are powerful consumer protection tools to protect against fraud.

First introduced in the 1970s as a way to combat credit card fraud, chargebacks protect the consumer against unauthorized transactions on their card by guaranteeing they’ll be able to get the money returned. Because the money is forcibly withdrawn from the fraudulent account, chargebacks also ensure that credit card fraud is less profitable, which helps to protect every cardholder.

Chargebacks also force merchants to be transparent about what customers are buying and to stay focused on providing great quality products and services. While genuine merchants will be doing this anyway, it helps to discourage scammers and people selling counterfeit goods.

When Can Customers Use Chargebacks?

As mentioned above, chargebacks are designed primarily to protect against credit card fraud and identity theft. In these cases, customers must contact their bank when they first notice fraudulent transactions.

In all other instances, customers must contact the merchant before filing a chargeback. Because chargebacks take a significant amount of time to resolve with the bank and have an array of consequences for the merchant, most banks will encourage customers to attempt to resolve a dispute with the merchant before using a chargeback.

If the merchant is unresponsive or unwilling to co-operate, customers can file a chargeback if they are still unhappy with the charge.

Business Consequences of Chargebacks

Chargebacks can have a significant impact on any business, both in the short and long term. Unfortunately for businesses, even if the chargeback is canceled or successfully disputed, that chargeback is still counted against them.

The first short-term consequence is that, if a customer files a chargeback after receiving a product, the customer does not have to return the product, and the merchant will lose the entire value of that sale.

Merchants typically face chargeback fees between $30-$100 per transaction, covering the bank’s administrative costs and a chargeback penalty. In addition, every merchant will be assigned a predetermined threshold for chargebacks. If the number of chargebacks they get in a month exceeds the threshold, then they will have to pay additional fines. Many of these fines can far exceed $10,000.

If this threshold is exceeded for several months, the merchant’s bank can freeze or terminate the account, meaning that they won’t be able to accept any card payments. If the account is terminated, then the merchant is placed on the MATCH list and won’t be able to open a new account with a new bank for at least five years.

Even if the merchant’s account isn’t closed, their bank might choose to force them onto a high-risk merchant account which comes with significant processing fees and other charges. These accounts may also restrict how much revenue the merchant can access, to mitigate the bank’s losses from chargebacks.

While merchants can dispute chargebacks, it takes a significant amount of time and resources to prove that the merchant acted legitimately. Even if they have a strong case, banks usually favor consumers. Plus, even if a merchant wins, the chargeback still counts against a merchant’s chargeback-to-transaction ratio.

Chargeback Fraud

One of the biggest problems with the chargeback procedure is that industry regulations haven’t kept up with the modern digital shopping landscape. With card-not-present transactions becoming the norm, there is nothing stopping customers from claiming legitimate purchases as fraudulent transactions under chargeback rules.

Unfortunately for merchants, 86% of all chargebacks are considered to be probable cases of chargeback fraud, and over two thirds of customers have openly admitted to filling chargebacks because they were more convenient than arranging a refund or return.

It’s worth noting that chargeback fraud isn’t always malicious or intentional. Because most customers don’t understand the difference between chargebacks and refunds, some instances of chargeback fraud can be attributed to this lack of understanding. It’s also likely that chargeback fraud may happen completely accidentally. Non-intentional chargeback fraud includes:

  • Customers filing chargebacks before attempting to resolve disputes with merchants
  • Customers wanting to get a refund for a faulty product or service, but the returns window has expired
  • Customers forget about a previous transaction they’ve made and erroneously believe a legitimate transaction is fraudulent
  • Family members make a purchase but fail to tell the cardholder, so the cardholder erroneously believes that it’s fraudulent

However, chargeback fraud can also be intentional and malicious. This typically happens when a customer doesn’t want to pay for a product or service they’ve received, so they use the chargeback process to claim they never authorized the purchase or received the product or service in question. Even though chargebacks can take months to resolve and for the money to be returned to a customer’s account, fraudulent chargeback claims still occur regularly.

Even if the merchant’s account isn’t closed, their bank might choose to force them onto a high-risk merchant account which comes with significant processing fees and other charges. These accounts may also restrict how much revenue the merchant can access, to mitigate the bank’s losses from chargebacks.

While merchants can dispute chargebacks, it takes a significant amount of time and resources to prove that the merchant acted legitimately. Even if they have a strong case, banks usually favor consumers. Plus, even if a merchant wins, the chargeback still counts against a merchant’s chargeback-to-transaction ratio.