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With more than 54 billion credit card transactions annually, credit card payments continue to dominate the payment landscape in the United States.[1]Capital One. “Number of Credit Card Transactions per Second, Day & Year.” Accessed August 09, 2024. Businesses must ensure adequate protection from fraudsters or irresponsible customers. This is especially true for businesses providing services or products upfront without full payment from customers.
Pre-authorizations help merchants protect themselves from financial losses. By placing a hold on a designated amount of a cardholder’s funds, businesses ensure there is enough money to settle a future transaction. This practice is commonplace in many sectors—such as the hotel and car rental industries—but it’s growing in popularity among businesses seeking to avoid chargeback fees, return fees, and other payment-related costs. Understanding pre-authorization charges and how they work can help your business reduce exposure to avoidable transaction issues.
This guide explores pre-authorization charges, how they work, when your business should use them, and other related topics. Read ahead to discover how pre-authorization can protect your business from chargebacks and refund fees!
What is a Pre-authorization Charge?
A pre-authorization on a credit card is a temporary hold placed by a merchant to verify a card’s validity and ensure there are sufficient funds for a potential transaction. When a customer makes a purchase, the merchant requests approval from the issuing bank to reserve a specific amount, typically the anticipated transaction total.
The bank verifies the card details and sets aside the funds, reducing the available credit limit but not completing the actual charge. Pre-authorizations usually expire after a predetermined period, during which the final transaction must be submitted. If the transaction doesn’t occur or the final amount differs, the pre-authorization hold releases, restoring the full credit limit. This process helps prevent overspending and confirms the cardholder’s ability to cover the intended purchase.
Pre-authorization charges are crucial for merchants to secure funds, validate transactions, and safeguard against potential losses, ensuring smooth and reliable payment processes.
When Would You Use a Pre-authorization?
The primary purpose of a pre-authorization hold is to verify that funds are available for a transaction. For example, when you use a credit or debit card at a hotel, rental car agency, or gas station, the merchant may place a pre-authorization hold on the cardholder’s account for an estimated amount. This can cover potential additional charges, such as room service, damages, or fuel. After the actual transaction processes, a final charge replaces the pre-authorization. If there are no additional charges, the pre-authorization hold may simply expire, and the funds will be released back to the cardholder’s available balance. This is a useful way to avoid rejected payments and other payment disputes. By ensuring a card is valid and contains necessary funds, merchants reduce the chances of a future declined payment.
However, using pre-authorizations has also become a popular tool for businesses seeking to avoid chargebacks, return fees, and other costs associated with payment processing. By using a pre-authorization for the first few days after a customer purchases a product or service, a business avoids exposure to chargebacks since customers can only file chargebacks on settled payments. If a customer raises a dispute before the payment is settled, a business can reverse the charge instead of suffering the consequences of a chargeback (such as increased chargeback ratio, chargeback fees, etc.). Likewise, if a customer wants to return an item, instead of processing a return, using a chargeback reversal helps merchants avoid return fees.
How Does Pre-authorization Work?
When a merchant pre-authorizes a card, its payment processor contacts the cardholder’s issuing bank to determine if the card is valid and whether there are enough funds to cover the charge. If the issuing bank confirms there are sufficient funds for the charge, the merchant places a temporary hold on the funds. This temporary hold means the cardholder cannot use the held money until the pre-authorization releases the funds back to the card. If it’s a debit card, this process involves holding the funds in the cardholder’s debit account. If it’s a credit card, this process involves holding funds from the cardholder’s credit limit. While this process sounds complicated, it happens almost instantly, ensuring there is no inconvenience for customers or merchants.
Think of pre-authorization charges as a financial security handshake. When you make a transaction, a merchant temporarily holds funds in a trusty handshake, ensuring you can cover potential expenses. Like a polite agreement, this hold assures the merchant you’re good for the money. After the transaction, the handshake concludes, and the actual charge takes its place.
How Long Do Pre-authorization Holds Last?
The duration of pre-authorization holds, also known as “pending transactions” or “pending charges,” can vary depending on the policies of the issuing bank or financial institution. Typically, pre-authorizations are temporary and may last anywhere from a few days to a few weeks.
However, while customers cannot file chargebacks on pre-authorizations, this doesn’t mean holding funds won’t frustrate customers. Make sure to work with a payment processor with swift pre-authorization refund timelines, as extended pre-authorizations may impact your business’s reputation negatively.
Pre-authorization Pros & Cons
As with any payment strategy, there are advantages and disadvantages to using pre-authorizations for credit card transactions. Let’s explore the pros and cons in more detail below:
Pros
Avoid chargebacks
Chargebacks result in significant losses for many businesses, and evidence suggests they play a significant role in the top priorities of e-merchants in 2023.[2]Statista. “Main priorities guiding fraud management strategies for online merchants worldwide from 2021 to 2023.” Accessed August 09, 2024. Pre-authorization charges are one of the many strategies your business can employ to reduce chargebacks.
If a scammer uses a stolen card to purchase goods or services from your business, but the transaction is only pre-authorized (not settled), then the issuing bank can cancel the charge instead of filing a chargeback. This helps businesses avoid chargeback fees and other issues associated with a high chargeback ratio. However, it will still result in losses from the goods or services received by the scammer.
Reduce fraud
Fraudsters use a range of sophisticated methods to swindle businesses out of money. Accepting credit cards without sufficient funds may result in losses for merchants. Pre-authorization charges allow your business to check if a credit card is valid or has sufficient funds prior to entering into an agreement with a customer. This is why hotels, rental car providers, and other similar businesses pre-authorize credit cards. They want to ensure they can charge the card if future costs arise (such as damages, etc.).
Avoid refund fees
Offering free refunds is commonplace for US retailers, but the process comes at a cost. Many merchant service providers charge chargeback fees to reverse payments, so your business will still be on the hook for fees if a customer returns a product. By using a pre-authorization for the initial days following a transaction, businesses can avoid refund charges if a customer returns an item before the payment settles.
Enhance customer experience
Pre-authorization charges enhance the customer experience by preventing consumers from overspending, ensuring seamless transactions, and providing a transparent process with temporary holds that protect against unexpected charges. By ensuring funds are held on your customer’s charge for a future transaction settlement, you help them avoid overdrawing their bank account or exceeding their credit limit by mistake. Pre-authorization charges play a significant role in helping customers spend responsibly.
Reduce processing fees
It’s not just refund fees your business avoids with pre-authorization charges. It’s also possible to reduce exposure to interchange fees. If a transaction is pre-authorized but canceled before settlement, the merchant doesn’t have to pay interchange fees. However, some merchant service providers may have other fees assessable if a pre-authorized charge is canceled, so read your merchant service agreement to check!
Cons
Customer confusion
While pre-authorization charges enhance the customer experience in some respects, they also create confusion. Customers may wonder why funds have been frozen in their accounts, which may lead to them contacting their issuing bank or your business to clarify the charge.
Customer apprehension
Some customers may feel apprehensive about allowing pre-authorizations. Depending on how you implement pre-authorization charges, this may deter individuals from using your business in the future.
Not foolproof
Unfortunately, while pre-authorizations provide an extra layer of protection from fraud, chargebacks, and other payment issues, they’re not foolproof. For example, just because you pre-authorize a card doesn’t mean the card will have enough funds to cover an entire purchase at a future date. Likewise, a pre-authorization won’t stop a fraudster from filing a chargeback when you settle a transaction in the future.
How to Pre-Authorize a Credit Card
The pre-authorization process may vary slightly depending on the purpose of the pre-authorization. Let’s look at some standard steps to take when pre-authorizing a credit card:
Choose a reliable merchant service provider
The most critical factor to consider when pre-authorizing a credit card is your payment processor. By choosing a merchant service provider with extensive pre-authorization tools, your business can utilize this form of payment hold to reduce exposure to chargebacks, declined payments, and other issues. Always ask a prospective payment processor if they offer easy-to-use pre-authorizations. It can make a world of difference for your business and its payment options. Likewise, a payment processor will be able to help your business remain compliant with best practices when pre-authorizing cards.
Obtain permission from your customer
Next, obtain permission from your customer to place a pre-authorization on their card. It’s critical they are aware you will hold funds on their credit or debit card. Make sure you communicate the amount of money the pre-authorization will hold.
Use your payment platform to process a pre-authorization
Now, it’s time to pre-authorize the credit card. This process will vary depending on your payment processor, so make sure to speak to your account manager about the best way to pre-authorize customer cards. Fortunately, most modern POS systems make it simple to place a hold on customer funds.
Notify your customer of the pre-authorization
Lastly, ensure your customer is fully aware that your business has pre-authorized a transaction on their card. This will save your business from dealing with future confusion or conflict. It’s also best to provide your customer with a timeframe for when the pre-authorization will re-release funds back to their account.
POS Pre-authorization: Closing Remarks
Pre-authorization charges are a useful tool for businesses seeking to avoid unnecessary chargebacks and refund fees. Likewise, they help many businesses avoid fraud by ensuring a card has funds available for future transactions. With the FTC recording 2.4 million instances of consumer fraud in 2022, pre-authorizations are a useful tool for protecting your business.[3]Federal Trade Commission. “Consumer Sentinel Network.” Accessed August 09, 2024. Still, while there’s no doubt pre-authorization charges are helpful for protecting a merchant’s interests, they can come at the expense of customers. Many may find it annoying to have funds held for multiple days.
Regardless, if your business wants to use pre-authorizations, it’s essential to work with a merchant service provider to implement this payment tool. These services offer dedicated account managers specifically tasked to help your business take advantage of the best payment options available. Your account manager will also help you access other critical payment tools, such as additional chargeback and fraud prevention software. Never underestimate the benefits of working with a merchant service provider!
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Frequently Asked Questions
How long does a pre-authorization take to cancel itself?
The time it takes for a pre-authorization to cancel itself will vary depending on the merchant, payment processor, and other circumstances. In most cases, a pre-authorization will cancel within a few days, but it may take a couple of weeks.
For customers, contact the merchant or your issuing bank if you believe a pre-authorization has taken too long to cancel itself. Merchants can contact their payment processor if they need help canceling a pre-authorization on a customer’s credit card.
What does pre-authorized debit mean?
A pre-authorized debit is a financial arrangement where a person or business grants permission for funds to be automatically withdrawn from their bank account as a recurring payment, typically for bills or subscription services. This differs from a credit card pre-authorization, which refers to a temporary hold placed by a merchant on a customer’s credit card to determine validity and available funds.
Does pre-authorization charge your card?
A pre-authorization does not officially charge a credit card. Instead, a pre-authorization charge places a “hold” on a pre-specified amount of funds until a transaction settles. Once a transaction settles, the pre-authorization becomes an official credit card charge. If a transaction doesn’t settle, the funds are eventually released back to the customer’s credit card. Regardless, while a pre-authorization isn’t an official charge, a cardholder cannot use the funds “held” on the card until the pre-authorization is canceled.
Do you get a pre-authorization chargeback?
Whether you receive the funds back in your account depends on whether the transaction is finalized. If a merchant finalizes the transaction, a regular charge replaces the pre-authorization. However, if a merchant doesn’t proceed with charging your card, the money will be released back into your account. In many cases, a pre-authorization charge will cancel itself after a few days, but it may take up to a few weeks.
How do I remove pre-authorization?
If a business places a pre-authorization on your card, it may take anywhere from a few days to a couple of weeks to remove it automatically. If you want to expedite the process, contact the merchant to ask if there’s any way to speed up the removal. However, if you believe a pre-authorization is fraudulent, contact your card issuer immediately to discuss the issue.
