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?
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.
But first, it’s important to note the difference between a credit and debit card pre-auth. A credit card hold only reduces the customer’s available credit. A debit card hold freezes actual cash funds in the customer’s checking account, which can trigger overdrafts or limit the customer’s use of their own money, leading to increased customer complaints.
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.
How long do pre-authorizations last?
The duration of an authorization hold varies significantly. While some transactions have a short hold, the window is largely governed by your merchant classification code (MCC) and the specific rules of the card network (e.g., Visa/Mastercard). For example, car rentals and hotels often have holds lasting 30 days or longer, while standard retail holds are much shorter.
If a merchant requires a longer pre-auth period, they must confirm their current MCC (which dictates the maximum hold duration) aligns with their business activities. If the current MCC is correct but the hold is too short, the merchant would need to split the transaction or initiate a re-authorization before the original hold expires, as the MCC itself cannot be arbitrarily reassessed for this purpose.
The alternative is to initiate an incremental authorization (or re-authorization) before the original hold expires. This is necessary because once a hold expires, the funds become available to the customer, and the subsequent authorization is not guaranteed.
The final step in the process is when the merchant confirms the final amount and sends the request to capture the authorized funds. This converts the temporary pre-auth hold into a finalized, settled transaction.
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 rental car agencies often use incremental authorization to increase the original hold amount (the pre-auth) throughout the stay. This allows them to add charges (like room service or incidentals) without running multiple separate transactions or exceeding the customer’s available credit.
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 filling up at a self-service gas station will find their card is pre-authorized for a larger amount (an estimated authorization, often $75-$100) before pumping begins. This holds a sufficient amount to cover the expected maximum purchase. The station then captures and settles only the actual final amount pumped.
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. A pre-auth is inherently safe because it is not a completed financial transaction, so the customer cannot dispute it via a chargeback. The risk of a chargeback only arises if the merchant incorrectly converts the pre-auth into a final charge.
Curbs payment processing fees. Pre-auths significantly reduce cost because they only incur a small, fixed authorization fee (typically a few cents) upon creation. The full percentage transaction fee (interchange, assessment, markup) is only incurred later when the authorization is captured and settled.
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. The release of reserved funds for a pre-auth is initiated immediately by the merchant upon completion (or cancellation). Crucially, this is often much faster than a refund. However, customers should be advised that the issuing bank may still take 24-72 hours to remove the visible hold from their account statement.
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.
FAQs about pre-authorization charges, pre-auths, and holds in payment processing
Q: What is a pre-authorization charge?
A pre-authorization charge, or pre-auth, is a temporary hold placed on a customer’s credit card by a merchant for certain transactions. It ensures that the customer has sufficient funds available to cover the requested amount without immediately debiting their account. This hold gives the original merchant priority over a specific amount in the customer’s account.
Q: How do pre-auths work?
Merchants can activate pre-auth functionality through their payment gateway provider, which is present in both physical credit card processing terminals and online portals for ecommerce payments. By adjusting the settings in their payment gateway, merchants can reserve funds from the customer’s credit limit, allowing them to pre-authorize a transaction amount.
Q: How long do pre-authorizations last?
Pre-authorizations typically expire after five days if the merchant takes no further action. However, this period can vary depending on the merchant classification code (MCC) assigned to the merchant’s account. If a merchant regularly needs to process pre-auths for periods beyond five days, they should arrange with their credit card processor to reassess their assigned MCC.
Q: What are the benefits of pre-authorizations?
Pre-authorizations offer several benefits to merchants, including:
- Merchant protection: Pre-auths provide security against loss or damage and are less risky than accepting cash deposits.
- Curbing payment processing fees: Pre-auths do not incur payment processing fees until the final charge is processed, unlike full charges and subsequent refunds.
- Faster access to funds for customers: Releasing reserved funds from a pre-auth is immediate, compared to the slower process of refunding funds from regular credit card transactions.
- Increased customer trust: By committing not to charge a customer unless certain conditions are met, merchants can improve conversion rates and persuade customers to make purchases.
Q: Are there any downsides to pre-auths?
The main risk for merchants using pre-auths is allowing the reserved funds to be released automatically before the transaction is complete. If a pre-auth expires after the standard five-day period and no further action is taken, the customer regains full access to their funds. To mitigate this risk, merchants should monitor the time since the initial pre-auth and promptly reattempt the pre-auth if it appears to be expiring before the transaction is settled.
