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What is a Chargeback? All You Need to Know

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Danny Randell | April 21, 2021

“What's a chargeback? How is it different from a refund? We answer your questions and tell you what your business needs to know if you encounter one.”
6 min read

    Chargebacks 101: What Businesses Need to Know

    What is a Chargeback?

    A chargeback occurs when a customer initiates a dispute over the legitimacy of a credit card transaction. The dispute usually arises due to an unfamiliar transaction that the customer notices in their bank account. If the customer decides to challenge this transaction, they will bring it to the attention of their credit card provider.

    While you might be able to run your business for years without encountering a chargeback, you should be well informed on the topic so you can be prepared when one does come your way. It is important to dispute illegitimate chargebacks if they occur to keep your business's chargeback rate low. If your business has a higher chargeback rate, it can compromise your reputation and diminish the number of banking institutions that want to work with you.

    Why Would a Customer File a Chargeback?

    Customers file a chargeback usually for two reasons:

    They encounter an unknown charge on their credit card (which can be a charge from something the customer has forgotten about or is not recognized by the customer because of how the charge is identified on their statement).

    The customer believes they were wrongly charged for an item (wrong price, bad quality, misled about the product or service, or they want a refund).

    Common Misconceptions About Chargebacks

    One of the most common misconceptions about chargebacks is that the disputes occur because of fraudulent credit card transactions. While this is one reason why a chargeback may be initiated, there are actually several reasons why a chargeback might occur, including but not limited to; if the customer continued to be billed after canceling a service, due to defective products, or if an order they placed wasn't received.

    Is a Chargeback the Same as a Refund?

    Think of a chargeback as the refund's grumpy elder brother, and where a refund comes from merchants, chargebacks come from a card issuer. Essentially, chargebacks are for when a customer and a merchant can't come to terms. Now often the reason they can't come to an agreement is because of poor (or nonexistent) return policies, inaccurate product descriptions, delayed shipping times, or sometimes because a customer has had their card information stolen. Let me explain:

    Real World Chargeback vs. Refund Example

    You're a good merchant right? So when a customer calls you up and says "My new set of tires you just sold me burst on the drive home", you're going to apologize profusely and offer to refund the customer, right? That's refunds 101.

    Alternately, imagine a customer comes in and buys four brand spanking new winter tires-your most expensive set-but a few hours later you get a call from a disgruntled cardholder who says they never bought those tires at all; their card was stolen, and used to purchase something they never wanted. Now we're in chargeback territory.

    The key here is to ensure that you've done all you can as a merchant to ensure safe protocols were enforced. This can include identifying any out-of-the-ordinary activity from the person you sold the tires to, and requiring chip & pin for the transaction to take place (this would be automatic in most cases where the cost of the transaction is over $250).

    In this case, because the person buying your fancy tires did use chip & PIN to complete their purchase, you as the merchant may have a way out of this unfortunate situation. The reason being that banks typically are willing to compensate customers for losses (out of the merchant's pocket) due to fraudulent NFC or online purchases, but when chip & PIN is used, the customer is typically at fault for letting their personal identification number fall into the wrong hands.

    How to Avoid Chargebacks

    In sum, keep your customers happy and avoid chargebacks in a few ways: make sure you have a good refund system in place to help your customers when something goes awry, keep an eye on recurring billing systems to ensure you're never charging a customer for something they are no longer receiving, and always be watchful for fraudulent transactions that could result in a chargeback.

    What to do When You Get a Chargeback

    Here is an overview of how the chargeback process works from beginning to end if a chargeback is initiated by a customer of yours (if they don't try to resolve it with you first) and what you can do to defend against the customer's claim if it is false.

    chargeback cycle

    1) The chargeback process begins when your customer takes a look at their statement and notices a transaction that they either: do not remember, did not authorize, or that they believe has been processed in error. Once the cardholder notices the transaction of concern, they will contact their issuing bank to dispute the transaction.

    2) Next, the card issuer will review the dispute filed by the customer to determine if the claim is valid. Sometimes the customer's bank will require some form of proof from the customer that their claim is legitimate. If they determine the claim to be invalid, then the process ends here; but keep in mind that the customer is entitled to consumer protections (one of the benefits of using a credit card) and the card issuer is likely to side with their customer in the event of a dispute.

    3) If the chargeback was determined to be valid by the card issuer, they will then submit the chargeback to the card network involved for reimbursement. The card network will instruct your acquiring bank or processor to immediately withdraw the funds for the original purchase, along with a chargeback fee (usually around 15 to 25 dollars), from your account to refund the customer. This ultimately means that your business has reimbursed the funds for the purchase to your customer and you will no longer have the proceeds from the transaction.

    4) When your business receives notice of the chargeback, you'll also receive instructions on how to dispute the claim if you wish to do so. If you know that the chargeback has been filed in error and that the transaction is valid, you can provide supporting details and documentation to dispute the chargeback and make your case.

    5) You will put together the documents needed for the merchant response to prove that the transaction was valid. Before submitting your document, be sure to look up the reason code for the chargeback so you can specifically address the reason the customer filed the chargeback. The information that you will need to fight a chargeback "“ and information you should collect if you're at all able "“ may include:

    "“ Date/Time Stamp for the transaction "“ The device used for the purchase "“ Shipping verification "“ CVV Match for the transaction "“ Device fingerprinting "“ Geolocation "“ Past transaction history "“ Subsequent transactions from the customer if applicable "“ Any email communications or interactions with the customer "“ Phone call transcripts "“ Live chat transcripts "“ Social media interactions and shares

    6) After you have submitted your supporting documentation to prove the transaction was valid, the acquirer takes your documentation and submits it to the card network, who will then give it to the issuer to review.

    7) Once the card issuer reviews the documentation for the dispute, they will determine whether the documentation you provided was enough to disprove the cardholder's initial dispute, or if the customer was correct and the chargeback will be upheld.

    8) If you lose the dispute, you can file for arbitration with the card network, but this can cost you upwards of 500 dollars or more. If you win the dispute, then the refund is reversed, and you are reimbursed for the funds for the initial transaction by the processor. Some processors will also refund the chargeback fee to you, but many will not. There is still a chance that the cardholder will dispute this outcome with a second chargeback and the process would begin again.

    Final Thoughts

    While chargebacks are not usually a frequent occurrence, they can happen, and you should be well informed on the topic so you can prevent their occurrence and increase your chances of winning any potential disputes. It is important to dispute illegitimate chargebacks if they occur to keep your business's chargeback rate low.

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