PayPal for Auction Users - How Does PayPal Work?

PayPal’s impressive growth has been propelled by its success with eBay auction buyers and sellers, and our PayPal overview explains the important need that PayPal filled for that audience. 

But what about those consumers who are considering signing up for a PayPal account for the first time, and are a bit unsure, and perhaps even anxious, about what they are getting into?

Let’s explore how PayPal works for a new user.

Signing Up For a PayPal Account

PayPal makes it easy for new users to sign up and use their basic service.  Early on in PayPal’s history, to fuel growth and encourage new users to enroll, PayPal deposited $10 into the accounts of the newly enrolled.  They also offered their current customers a $5 bounty for any new users that they referred to PayPal.  As a very successful business with over 150 million users, they no longer need to offer these kinds of bonus programs to attract new customers.

It costs nothing to sign up for a PayPal account, and sending money to someone from your PayPal account is always free.  Receiving money is initially also free, at least until you reach certain use thresholds.  After that, PayPal charges transaction fees for money sent to you from others.  We’ll explore that in more detail later.

To enroll in PayPal, you first fill out a short form at their website.  They ask for the usual information; name, address, email address, phone, username, password, etc.

Once you have completed the enrollment form and agreed to their terms and conditions, they send a confirmation email to your email address.  After you confirm your email address by clicking on a link provided within the email, you’re enrolled to use their service.

When you first login to your new account, they will encourage you to “verify” your account.  There are a couple of ways to do this, but most people do so by adding their checking account information to their PayPal profile.  Is that safe to do?  I’d say yes.  PayPal has enough history under their belt to be able to accurately claim that they have adequate controls in place to protect a consumer’s sensitive financial information.  If they didn’t do this well, they wouldn’t remain in business long.

The verification process does a couple of things for PayPal.  It helps them authenticate that you are who you represent to be, and from a payment risk perspective it helps protect both them and you.  It also allows them to lift the payment limits that they establish for you when you first enroll but are not yet verified.  A new user who is unverified is limited to receiving $500 per month, and limited to withdrawing no more than $500 per month from their PayPal account.  Once verified, these limits increase to $2000.

How Verification Works

Within a few days of entering your checking account information, PayPal will make two electronic ACH deposits of random amounts that are less than $1 to your bank account.  Your account remains in unverified status until you can prove to PayPal that you own access to the enrolled bank account.  You do this by entering the exact amount of the deposits into your profile in PayPal.  You can easily figure out how much the deposits were by going online with your financial institution and reviewing recent deposit history, or from looking at your checking account monthly statement.  The deposits will typically be made 3 – 5 days after you first enter the account information into PayPal.

There’s an additional benefit to getting verified for auction buyers.  Auction sellers like to know that their buyers are verified PayPal users, because the risk to them of the transaction being problematic is reduced if someone has gone to the trouble to verify their account.  eBay offers some special seller protection for selling and shipping goods to verified PayPal user addresses.

Making a Payment

Let’s assume you are making a payment while in unverified status.

To make a payment, you can click on the PayPal link embedded within the email that eBay sends you when you win an auction or you can login to your PayPal account and click on the “Send Money” tab.

Since you haven’t verified your bank account, you must use a credit card to fund the payment.  If you followed an eBay notification email link to PayPal, PayPal will already know who you are trying to pay and will pre-fill the seller’s information for you.  If you are paying for something that is not auction related, you can find the person by entering their email address that they used when they registered with PayPal. 

Fill in the required credit card information and you’re done.  PayPal emails a transaction receipt to both the sender and receiver.  You can also review transaction details from the PayPal account activity page.  Your credit card information will be stored in your PayPal profile so that you can use it again for future payments.

Making a Payment (Verified Users)

The process changes slightly for verified users.  Since verified users have enabled their checking account with PayPal, these users are encouraged to use their checking account rather than a credit card to fund the payment.  PayPal does this because they make all of their money on non-card type transactions.  To understand why, you’d have to review the article on Credit and Debit Cards to see how credit card interchange works.  For the sake of simplicity, PayPal pretty much breaks even on transactions funded by credit cards, but they make quite a hefty on transactions that are funded with bank accounts.  This is due to the fact that they charge the same fees whether the transaction was card based or bank account based, and the cost to them for processing a non-card payment is mere pennies.

So, while you can continue to make credit card payments after you become a verified user, PayPal really wants you to fund the transaction with your bank account.  Should you want to fund the payment with your credit card, you can do so by clicking on the “More Funding Options” link and changing the selection of the funding account to be your credit card.

Receiving Payments

For PayPal users who are signed up for the basic personal account, they can receive payments from other users for free (up to your established account limits), as long as the money for the payment is funded from the sender’s verified bank account.  Again, remember that it costs very little for PayPal to process a checking account payment.

Things get more complicated when you attempt to accept credit card payments.  PayPal will only allow a handful of credit card payments to you before they will insist that you upgrade from a basic account to their premier or business account status.  If you stay within the monthly receiving limitations for your basic account, you are allowed to receive up to five card payments per year.  However, these card payments are not free, and carry a fee equal to 4.9% of the payment amount, plus $0.30.  The fee is automatically deducted from the payment before it hits your account.  So, if someone sends you $100 via credit or debit card, you will receive just $94.80 of the $100.  Additionally, PayPal further restricts card payments by not allowing users with basic accounts to receive any card payments at all for eBay transactions.

It’s easy to see from this pricing strategy that PayPal wants users to upgrade to their premier service.  Once they upgrade, there is no going back, and at the premier level users pay transaction fees for every payment made to them, regardless of how the payment was funded.

Getting Your Money

Getting your money out of PayPal is easy.  If you have a verified bank account in your profile, you can request to withdraw PayPal funds and to have them make an ACH deposit into your bank account.  This costs you nothing and takes about 3 days for the funds to get show up in your account.  Otherwise, you can request that PayPal mail you a check, but you will be charged $1.50 for this and it can take a few weeks to receive it.

A less frequently used alternative is to sign up for a PayPal debit card, which can be then used to make purchases anywhere that MasterCard is accepted, up to the amount that is in the associated PayPal account.  This debit card can also be used to make withdrawals of PayPal funds from any ATM ($1 fee for this option).

Stored Value Account

In case you are still confused about how all of this works, here is one more bit of information that may help to clarify.  PayPal is based upon what is referred to as a stored value account.  Stored value accounts are essentially holding accounts where money sits until the owner decide to move it elsewhere.  PayPal earns interest on funds that reside in user accounts. 

When you make a PayPal payment to someone, you are authorizing PayPal to fund your PayPal stored value account from a credit card or a verified bank account, and to then move the funds from your stored value account to the stored value account of whoever you are attempting to pay.

PayPal’s absolute favorite transactions are those where someone wants to make a payment using funds that are already sitting in their PayPal holding account.  These are by far their most profitable transactions, since there is effectively no cost involved for PayPal.  They simply post a debit transaction against the sender’s PayPal account, and post a credit transaction over to the receiver’s PayPal account.  The nearly 3% transaction fee that PayPal gets is pretty much all pure profit.