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Finding Out How PayPal Works

Like many great ideas, the fundamentals of PayPal are pretty easy to grasp. Your PayPal account is much like any savings or checking account, except PayPal was designed specifically for online transactions. Before you can start using PayPal, the first thing you need to do is open a PayPal account. Consider starting with a Personal account, because you have no fees associated with sending or receiving money. After you get your feet wet, you can always upgrade to a Premier or Business account.

You are required to upgrade from a Personal account to a Premier or Business account if you send payments totaling $2,000 or more. This limit may vary, depending upon whether you have a U.S. or International account. There may also be limits on how much money you can transfer from your PayPal account to your bank account. To see what limits apply to your account, click the View Limits link, located to the right of your account balance box, on your Account Overview page.

Money makes the (PayPal) world go 'round

Okay, you're convinced and you opened a Personal account. Now what? An account without funds is like a cone without ice cream — what's the point? You need to get money into your PayPal account before you can start doing anything.

You add funds to your PayPal account in one of three ways:

  • By receiving payments from other PayPal members
  • By linking a savings or checking account to your PayPal account and using Electronic Funds Transfer (EFT)to transfer money
  • By getting interest payments on the funds that are in your PayPal account

When you make a payment with PayPal, you have several funding sources from which to choose to finance the transaction. These sources include the following:

  • If you have enough funds in your PayPal account to cover the payment you want to make, the funds are deducted directly from your PayPal account.
  • If you have linked a checking or savings account to your PayPal account, the funds can be deducted directly from your bank account in the form of an eCheck.
  • If you link a credit card to your PayPal account, the payment amount can be deducted from your credit card after you've depleted the funds in your PayPal account balance. The payment shows up on your monthly credit card bill.

The process for buying a good or service using PayPal is very straightforward:

1. After winning an auction or purchasing an item, if you opt to use PayPal for payment, PayPal deducts the amount of your purchase from funds in your PayPal account or authorizes payment from the credit card you have linked to your PayPal account.

2. PayPal credits the seller's account with the funds deducted from your account (less any applicable transaction fees). Fees only apply to sellers with Premier and Business accounts.

3. PayPal generates e-mails to you (the buyer) and the seller to confirm the transaction and the transfer of funds.

The actual transfer of funds is no more complicated than if you were to pay for an item with a check from your checking account.

How PayPal makes money

Just like a bank, PayPal makes money off the "float" of the funds they manage. In other words, PayPal is earning interest against the money that you (and millions of others) have placed into their accounts, but not spent yet.

Think of it this way: PayPal has roughly 50 million members. If each member left $10 in their account for a year, PayPal would start with around $500 million dollars as principal. Even at an interest rate as low as 1.75 percent, PayPal would be earning $8,750,000 every year, just for letting the money sit there!

Additionally, PayPal makes money by charging transaction fees for Premier and Business accounts: There's no charge to send money, but when you receive money, PayPal takes a percentage of the amount (between 1.9 percent and 2.9 percent) plus a 30-cent USD transaction fee.

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