The Complete Guide to Payment Fraud
Payment fraud is when payment information (like a credit card or bank account) is used as part of a fraudulent transaction.
Often, payment fraud involves stealing a victim’s payment information, but that isn’t always the case. For example, illegitimate refund requests are another form of payment fraud.
Researchers predict online payment fraud will cost retailers more than $340 billion over the next five years. And, LexisNexis reports every dollar of fraud costs U.S. merchants $3.75.
For both financial institutions and businesses, payment fraud can cause immense damage. Today, we're showing you what major types of fraud there are and how you can protect yourself against them.
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What are the types of payment fraud?
Payment fraud comes in many forms. There are many ways fraudsters can trick an unsuspecting consumer or merchant, so let’s review common types of payment fraud.
Credit card fraud
We’ll begin with one of the most basic types of illegitimate transactions: credit card fraud. This can happen when a fraudster steals a credit card or credit card information. Then they use the card to make fraudulent payments.
Normally, when the real cardholder notices the unusual activity and suspicious transactions on their bank account, they dispute the charges. Often, this results in a double whammy for merchants. The merchant loses revenue and the goods that were shipped to the fraudster.
Sometimes, it's a more elaborate case of identity theft, when the scammer steals personal information from someone that goes beyond credit card information.
Card testing
Card testing is a bit more intense than credit card fraud. It entails using bots or scripts that can make hundreds to thousands of low-value fraudulent purchases to test for valid credit cards. This type of payment fraud can put a huge financial strain on merchants once the chargeback requests roll in.
Fake return of merchandise
This type of fraud is much harder to detect. You won’t know until the consumer has reached out to claim they never received their order and would like a refund.
They also might say they’ve shipped the item back in the hopes they’ll get their money back. If there was no proof of return, the merchant might not find out till weeks later that the merchandise was never actually returned.
Chargeback fraud
Chargeback fraud is similar to fake return fraud in that both result in the consumer asking for a refund. The difference here is that a consumer or fraudster bypasses the merchant and requests a refund from the bank.
Sometimes, chargebacks are legitimate. Chargeback fraud occurs when a chargeback is requested for an illegitimate reason. For example, a fraudster may receive an item, claim they did not, and request a chargeback through the issuing bank.
Friendly fraud
The term “friendly fraud” is often used interchangeably with chargeback fraud. However, friendly fraud only covers a subset of chargeback fraud cases. Friendly fraud occurs when a customer believes they are legitimately entitled to a refund, but contacts the issuing bank without giving the merchant a chance to handle the situation.
For example, a customer might not recognize a transaction on their bank statement, or someone else in their household may have made the purchase. Instead of contacting the merchant to resolve the issue, the customer goes directly to the bank and files a chargeback.
Merchant identity fraud
Perhaps more insidious than the types of fraud mentioned above is merchant identity fraud. Where the other types of transactional ploys involve a cybercriminal acting as a consumer, merchant identity fraud involves the cybercriminal playing the role of the merchant.
The fraudster might set up an ecommerce site to look nearly identical to an unsuspecting consumer. The person behind the fake site can then obtain the consumer’s card information when they make a purchase.
Once the false transaction is complete, the person who made the false merchant account can simply terminate and walk away with the money after they commit fraud.
Phishing
You’ve probably heard of phishing scams in terms of email as a channel. This is when someone receives a deceptive email letting them know their account has been compromised and that they need to reset their password in order to protect their information.
This is exactly what happens during a phishing attempt at payment fraud. A fraudster might send out emails to consumers letting them know something went wrong with their order or that there is a problem with their account.
The consumer will then follow the link in the email to reset their billing or account information, and the fraudster will then steal all the information. This commonly starts with a business email compromise and leads to multiple fraud attempts from one contact.
Account takeover fraud
Account takeover fraud occurs when a cybercriminal gains unauthorized access to a legitimate user’s account. This can happen through phishing scams, credential stuffing, or malware that captures login information.
Once the fraudster takes control, they can change account details, make purchases, or withdraw funds. In some cases, they may also use stored payment methods to conduct additional fraudulent transactions across multiple platforms.
From a merchant’s perspective, this type of fraud can be especially damaging because it often appears as legitimate customer activity. By the time the real account owner notices, the transactions have already been processed, and chargebacks may follow.
Invoice fraud
Invoice fraud happens when a fraudster manipulates or fabricates invoices to trick businesses into sending payments to the wrong account. This often targets companies that process large numbers of invoices or rely on email for billing communications.
The scam can involve impersonating a known supplier, altering bank details on a legitimate invoice, or creating fake ones that look nearly identical to real documents. Once the payment is made, the money is transferred to an account controlled by the fraudster.
To prevent this type of fraud, businesses should verify any payment detail changes directly with suppliers and implement strict approval processes for financial transactions.
Card not present fraud
Card not present (CNP) fraud occurs when a transaction is made without the physical card being used. This type of fraud typically happens in online or phone purchases, where only the card number, expiration date, and security code are required.
Fraudsters often obtain this information through phishing, data breaches, or skimming devices. Once they have the details, they can make unauthorized purchases that are hard to detect until the legitimate cardholder reviews their statement.
Because no physical verification takes place, CNP fraud can be difficult for merchants to prevent. Strong authentication tools, such as two-factor verification and fraud detection software, can help reduce the risk.
How does fraud happen?
Payment fraud happens when a fraudster finds weaknesses in the transaction process or in human behavior and exploits them for financial gain. These attacks can occur at several points in a transaction, during checkout, payment authorization, refund requests, or even merchant onboarding.
Common ways payment fraud happens include:
- Stolen credentials: Fraudsters steal card numbers, login details, or bank information through phishing emails, malware, or data breaches. They then use those stolen credit cards and data to make unauthorized purchases, through venues like instant payment systems, point of sale terminals, etc.
- Social engineering: Scammers trick customers or employees into revealing private information, often by impersonating a trusted source such as a payment processor or a bank representative.
- Account takeover: When criminals gain access to a customer’s online account, they can change shipping addresses, make purchases, or withdraw stored funds, which leads to account takeover fraud.
- Fake merchants: Some fraudsters create counterfeit online stores that look legitimate, collect payment details from unsuspecting buyers, send them payment instructions that look legit and disappear after transactions are made.
- Refund and chargeback abuse: Fraud occurs when someone requests a refund or chargeback on a valid purchase to reclaim money while keeping the product or service after transferring money.
In short, fraud happens when there’s an opportunity, whether through technical vulnerabilities, weak authentication in payment instruments, or gaps in merchant policies with the credit card company. Understanding how fraudsters operate helps businesses put the right safeguards in place before losses occur.
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Payment fraud can affect any size company
Cybercriminals know how many consumers these days are relying on online purchases. Payment fraud can affect both large and small businesses. Whether you’re a smaller mom-and-pop shop that just began offering online payment options, or you’re a larger, more established online business, it’s always important to look for the warning signs of fraud.
This being said, fraudsters might be more inclined to focus on smaller businesses that don’t have as many protective tools in place. The less secure your fraud-protection system, the easier it is for cybercriminals to attack your business.
When it comes to fraud, it’s not just your business’ finances that will be hurt. Your customers’ trust could also waver. If they learn about security issues with online payments, your customers might rather spend their money where they can count on their personal information staying safe.
How to prevent payment fraud
There are steps you can take and tools you can use to reduce your chances of fraud affecting your company and customers. Here are some tips to help you prevent fraud:
- Leverage encryption and secure payment gateways – Secure payment gateways help you encrypt and secure ecommerce payments. The right gateway can help solve many of the technical and compliance issues involved with securing online payments.
- Follow the principle of least privilege for customer and transaction data – The principle of least privilege means only granting access to a person (or system) required to do their job. Be sure to keep customer and payment data on a need-to-know basis that is compliant with PCI DSS.
- Stay informed about emerging fraud trends – Ecommerce is continuously evolving, and so is payment fraud. Fraudsters won’t stop when they hit roadblocks like authentication procedures and secure payment portals. They’ll simply find new ways to commit payment fraud, and your business needs to keep up.
- Invest in employee education - if you want to protect customers against fraudulent activities, invest in employee training. Educate employees about the most recent fraud trends and security measures you can take to protect yourself.
- Do (some) customer education too - to protect customers from falling victim to fraud, you can give them some advice, such as installing the right antivirus software, never to give out sensitive information through forms, or to watch out for grammatical errors to recognize fraudulent emails.
- Partner with the right payment solutions provider – Mitigating payment fraud risk is a complex task. It requires the right mix of technical, financial, and compliance knowledge. A trusted payment solutions provider, like TailoredPay, can help you find the solutions your business needs at an affordable cost and come up with a fraud strategy that protects your business.
- Make it easy for customers to contact you and request refunds – Friendly fraud often occurs because a customer is legitimately confused about a transaction. For them, it’s easier to file a chargeback with their bank than it is to contact the merchant. Making it easy for customers to contact you can prevent many cases of friendly fraud before they begin.
- Invest in chargeback mitigation – Chargeback mitigation services empower you to detect and respond to chargebacks early on. As a result, you can reduce the risk of payment fraud, provide refunds to legitimate customers, and protect your profits.
Last but not least, invest in the right payment processor for your business.
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