What is a chargeback?

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June 15, 2023
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What is a chargeback?

Chargebacks, when a customer disputes a debit or credit charge and their bank reverses the transaction and returns their funds, are essential to the payment ecosystem.

They are a tool that customers can use to address fraudulent transactions and protect against undelivered or damaged items. This increases confidence in online card payments.

However, charges for handling chargebacks and resources that are required to manage them make them costly for merchants. As well as this, the rules are weighted in the consumer's favor which has provided fraudsters the ability to 'game' the system.

In this article, we explain more about what a chargeback is, what types of chargeback exist, how chargebacks work and how to minimize their impact.

Chargeback explained

A chargeback is the return of funds to a customer’s account after they dispute a card payment.

Some reasons chargebacks may happen are if a cardholder claims:

  • a card payment was fraudulent,
  • the services were not provided, or
  • the merchandise never received

Chargebacks are also known as disputed payments or disputes. The classical definition of a dispute in the card industry is a transaction that an issuer returns to an acquirer.

Once a consumer initiates a chargeback, the disputed charge will essentially go back and forth between the issuer and the acquirer. That’s until one of them agrees to accept liability for the charge, the dispute resolution process is exhausted, or the card scheme resolves the dispute—whichever comes soonest.

What are the different types of chargebacks?

In the following we explain the three different types of chargebacks.

Criminal fraud

A chargeback initiated as a result of a genuine fraud attempt is exactly the situation that chargebacks were designed for. Also known as a true fraud chargeback, they can prevent a criminal successfully stealing funds by reversing any suspicious and unauthorized credit card charges. For this reason, merchants should not dispute criminal fraud chargebacks.

Criminal fraud chargebacks can be avoided by using fraud detection tools to identify and decline fraudulent transactions, and by using authentication protocols like 3D Secure to verify customers.

Friendly fraud

Friendly fraud chargebacks occur when a customer claims a legitimate charge is fraudulent in order to reverse it. They can do this maliciously or simply because they struggle to identify a genuine transaction on their bank statement.

Because it’s hard to prove intent, friendly fraud chargebacks can be difficult to prevent. You can, however, attempt to recover lost funds through representation, where you submit evidence to the bank that a transaction was genuine.  

Merchant error

Some chargebacks occur due to a merchant error in the processing or fulfillment of a purchase. The only way to avoid merchant error chargebacks is to limit mistakes in your operations and to have adequate customer service on hand to deal with any issues.  

Learn more: chargebacks vs. refunds

What is the chargeback process?

The chargeback process begins when the cardholder disputes a transaction. It then goes through several stages before it's resolved. The process differs slightly depending on the card scheme, but all disputes follow a similar pattern.

1. Cardholder contacts their issuer

The cardholder initiates the chargeback process by contacting their issuing bank to query a disputed transaction.

2. Issuer creates a dispute case via the card scheme

The issuer reviews the disputed transaction, creates a formal dispute case via the relevant card scheme and assigns a chargeback reason code, which describes why they are charging back the transaction.

3. Acquirer receives and reviews the chargeback

The acquirer receives notification of the chargeback via the relevant card scheme. If they have evidence to counter the chargeback, they submit it on the merchant’s behalf. If no such evidence is available, the acquirer will ask the merchant to supply evidence.

4. Merchant receives and reviews the chargeback

The merchant reviews the chargeback and responds via their acquirer. If the claim is legitimate, the merchant will merchant accept the chargeback. Or they challenge the chargeback if they have compelling evidence the claim is illegitimate.

Learn more: Visa Compelling Evidence 3.0

5. Issuer reviews evidence and decides on the chargeback

The issuer reviews the evidence received from the acquirer and decides on the case. If the evidence refutes the cardholder’s claim, the merchant wins. If the evidence does not refute the cardholder’s claim, the merchant loses.

6. Cardholder and merchant are notified of the decision

The cardholder and merchant are notified of the case decision. If either party disagrees, they may have the option to argue further via an arbitration process, depending on the circumstances of the case.

What are chargeback reason codes?

Chargeback reason codes are letter or number sequences that describe why a chargeback has been initiated. The codes act as an efficient method of letting the merchant know whether a chargeback is the result of, for example, a processing or authorization error or because of a consumer dispute.

You can find a comprehensive list of chargeback codes and their meanings in our dedicated page.

When can a cardholder use chargebacks?

Cardholders may be entitled to use chargebacks if they see fraudulent or unauthorized charges on their account. Or if they are dissatisfied with goods or services and have not been able to resolve the issue directly with the merchant.

For example, in cases where:

  • Goods never arrived, or services were not rendered
  • Goods arrived damaged, defective or not as described when purchased
  • Incorrect charges were applied e.g. incorrect totals, additional or duplicated charges, recurring payments that were canceled

That said, chargebacks are not a replacement for customer service and should not be initiated every time a cardholder is unhappy with a product or service. Their first port of call should always be to speak to the merchant. If the merchant is unable to satisfactorily resolve the dispute, then the cardholder can explore initiating a chargeback.

Learn more: Chargeback pre-arbitration & arbitration explained

How long does a chargeback take?

The chargeback period, or the time limit for filing a chargeback, depends on the card scheme and the chargeback reason code. It can range from 60 to 120 days from the billing date.

The time limits for responding to a chargeback also vary based on the card scheme and the chargeback reason code. It’s important to note that time starts when the issuer creates a dispute case via the card scheme, not when the merchant is notified of the potential dispute or chargeback.

Acquirers may set their own deadlines for merchants to respond. But typically, merchants have 10 to 20 days to respond to a chargeback notification and provide compelling evidence.

Resolving a chargeback can take anywhere between a few days to several months depending on the complexity of the case and other factors.

What do chargebacks mean for merchants?

Chargebacks could leave businesses that accept cards to lose money in three main ways:

  1. The goods have already been shipped or the service has already been provided
  2. Payment is not received if the chargeback is successful
  3. Administrative costs are incurred when choosing to challenge the decision via the chargeback representment process

If a business receives too many chargebacks, it could be forced to work with high-risk processors charging higher fees, which adds to the cost of card acceptance. Or, in a worst-case scenario, business could lose card acceptance, if they persistently appear on card scheme chargeback compliance programs.

Learn more: How to prevent chargebacks.

What is a chargeback fee?

A chargeback fee is an amount charged by the acquirer and paid by the merchant on top of any returned funds. These fees are designed to incentivize merchants to do their best to avoid experiencing too many chargebacks. Repeat offenders may be placed on programs such as Mastercard’s Excessive Chargeback Program (ECP) or Visa’s Dispute Monitoring Program, which levy fines against merchants that fail to get their chargeback ratios below certain thresholds.

Reduce chargebacks with Checkout.com

Even the most diligent businesses will experience chargebacks from time to time, but there are steps you can take to limit their occurrence, and Checkout.com can help.

Our Fraud Detection Pro solution stops chargebacks before they occur by spotting and preventing fraudulent transactions. It uses a combination of machine learning and flexible rules to protect your business while increasing your acceptance rate for legitimate purchases.

And with Rapid Dispute Resolution, we can help merchants automatically resolve disputed transactions before they turn into chargebacks. You can create rules to dictate which disputes you want to resolve; then, when a customer challenges a charge, you can automatically credit their card at the pre-dispute stage. This means you avoid financial penalties, and disputes don’t count towards your chargeback ratio.

Learn more: How to win credit card disputes

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June 15, 2023 5:16
June 15, 2023 5:16