B2B Credit Card Processing: Overview, Fees, and How It Works

Credit card usage in the United States has never been higher and over 90% of Americans own at least one credit card. Though the way in which they are used and processed has evolved over time, the popularity of credit cards has only increased since the first universal credit card was introduced to the US by Diner’s Club in 1950.

Convenience, both for the buyer and the seller, is one of the primary reasons for the enduring appeal of the credit card, making it increasingly important for merchants to be able to accept payments by credit card today. But how do merchants process credit and debit card payments and what is meant by a pre authorization on a credit card?

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What Does Pre Authorization Mean?

In the world of electronic payment processing, a credit card pre-authorization refers to the process of placing what is effectively a holding charge on a customer’s credit card. The issuing bank checks to ensure that the customer’s payment can go through and there are sufficient funds available to cover the requested amount, without actually debiting the cardholder’s account right there and then.

This pre-authorization hold places the authorized funds into a temporary reserve to prevent the customer from withdrawing or spending that money elsewhere. It’s effectively giving the original merchant priority over a particular pool of cash in the customer’s account. The possible reasons for wanting to do this are laid out below.

How Do Pre-Auths Work?

Any merchant able to accept payments by credit card will have a relationship with a payment gateway provider that allows for the processing of electronic payments. Payment gateways exist within physical credit card processing terminals as well as online, as part of a portal for accepting eCommerce payments, and can be configured based on the needs of the merchant.

By adjusting the settings in their payment gateway, merchants can activate the functionality to pre authorize customer payments, sometimes called a reserve (because you’re reserving the funds from the available balance of that customer’s credit limit). Once set up, it’s possible to pre authorize a transaction amount, allowing for all the benefits this entails. More on that below.

How Long Do Pre-Authorizations Last?

Typically, a pre-auth will be set to expire after five days if no further action is taken by the merchant, though this can depend on your Merchant Classification Code (MCC). There are some cases where standard pre-auths will invariably need to be longer and this should be reflected by the appropriate MCC that has been assigned to your merchant account.

If a merchant is regularly having to process pre-auths for periods beyond five days, they’d typically need to arrange with their credit card processor to reassess their currently assigned MCC.

The alternative is to run the pre-authorization again after the original five-day pre-auth has expired, but this won’t always guarantee funds remain available so it’s wise to try and implement a longer pre-auth period where more than five days per transaction is regularly required.

What Are Pre-Auths For?

There are a number of common use case scenarios for pre authorizing payments via credit card, particularly within the travel sector. For instance, car hire companies normally require that a customer commits to paying for any damages they might cause during the period of their rental by putting down a security deposit. This security deposit is usually claimed via a pre-auth charge, holding the authorization amount for the rental company to deduct any funds to cover damages (or fines) upon return of the vehicle.

In a similar fashion, hotels and vacation rental property operators tend to request pre-authorization on a credit card before allowing guests to check in. For hotels, this ensures that the guest can’t rack up a bill (e.g. for room service or use of facilities incurring an extra charge such as a spa or laundry service) they later don’t pay for (intentionally or otherwise).

While for vacation rentals, such as an Airbnb, the pre-auth acts as a security deposit, much like it does for the rental car company, ensuring funds can be claimed for any damages that might be caused during the stay.

Of course, the travel industry isn’t the only sector in which pre auths are popular. Ultimately, they can be utilized in any situation where a merchant or service provider wants to cover themselves against loss or damage.

Customers might also find their card is pre-authorized before being allowed to fill up at a self service gas station, to ensure that they can’t leave with more than they’re able to pay for.

What Are the Benefits of Pre Authorizations?

Now that we’ve covered the benefits of pre authorizations, let’s look at the benefits of implementing them.

Merchant protection. The primary benefit of a pre-auth is in offering protection to the merchant. It provides security and cover in situations where there might otherwise be a risk of loss or damage. This is more secure and less risky than accepting cash deposits for the same purpose. Cash can be lost or stolen whereas a pre-auth can’t be reversed by the customer via a chargeback, a common technique used by fraudsters.

Curbs payment processing fees. Pre-auths carry the advantage of incurring no payment processing fees until a final charge is processed, whereas a full charge and subsequent refund would incur fees at both ends of the transaction (i.e. fees for processing the initial payment along with refund fees).

This is particularly useful in situations where you might wish to automatically process payments before determining whether you can actually fulfill the order.

Let’s say you have an online store that a customer has ordered from but on closer inspection, you determine you’re out of stock of the requested item(s) or you can’t ship to their location. Rather than having to refund the customer’s credit card transaction and paying the associated fees, you can simply release the funds from the pre-auth and nobody would be charged anything.

Makes funds more accessible, compared to refunds. There are benefits from the customer’s perspective too, as the release of reserved funds for a pre-auth is immediate, providing them with instant access to their previously earmarked money. This is in contrast to the method by which funds that have already been taken through a regular credit card transaction are later refunded, which can take several days.

Gives customers peace of mind. One further fringe benefit to the merchant is in being able to offer peace of mind to the customer. The commitment to not actually charge a customer unless or until certain conditions are met can help persuade them to buy from you, which improves conversion rates on a website and acts as a convincer helping with a salesman’s pitch.

Are There Any Downsides to Pre Auths?

As a merchant, the main risk with a pre-auth is allowing the reserved funds to be released automatically, before the transaction is complete.

As previously discussed, there is a standard five-day period for most pre-auths, after which time if no further action is taken the pre-auth will expire and the customer will regain full access to their funds.

This is why it’s important for merchants to keep on top of the period of time since the initial pre-auth was made and if it looks to be coming to an end before you’ve settled your original transaction with your customer a prompt reattempt at the pre-auth would need to be made.

There could be a very narrow window within which to commit your second pre-auth if the customer is savvy enough to recognise when the pre-auth will expire and is ready to exploit it.

Of course, most customers aren’t going to be counting down the minutes until the pre-auth runs out but it’s still something to be aware of in a world where credit card fraud is on the rise.

Final Words

Would being able to accept pre-auths benefit your business? Stax enables you to easily implement pre authorizations, so you can streamline your operations and enhance customer satisfaction. Contact us to learn more.

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