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Credit Card Pre-Authorization Explained

Sometimes it pays to do your research, and pre-authorizations in the payment processing world are a great example of that. Pre-auths aren’t the best option for every business, but depending on your industry and client base they could help reduce costly chargebacks and other fees.

What is Pre-Authorization?

A pre-authorization is a temporary hold on funds in a customer’s account that lasts 3-5 days.

Unlike an actual transaction, you aren’t moving any funds yet, it simply puts an official hold on those funds until the post-authorization comes through.

The duration of that hold is typically three to five days, but it varies and is ultimately determined by your Merchant Classification Code or MCC. Just be careful about extending a hold for too long. Sometimes customers will move funds around, and your transaction could be denied.

The value of a “hold” is that those funds are technically tied up in the customer account — they can’t just go spend that money. It’s like when you’re waiting for a check to clear and you see your new balance in your account. You know the funds aren’t actually there yet, but you also know they’re officially on the way.

And if you (the merchant), don’t follow up with a post-authorization within the holding period, the issuing bank will release the on-hold funds back to the customer, eliminating the transaction. Expired holds like these are known as a “falling off”.

What is a post-authorization?

A post-authorization is just an official confirmation of the pre-authorized transaction, and this occurs during your batching process.

The Benefits of Pre-Authorization

Reduce fraud and consequential chargebacks

Pre-authorizations reduce damages from fraud because if you choose to pre-authorize instead of transacting, and the customer happened to be using a fraudulent card, that customer can’t issue a chargeback for that transaction because the funds were never actually used.

This saves you in fines, headaches, and keeps your reputation free from chargebacks — this is an especially important mechanism for online merchants.

Reduces transaction costs

On a similar note, by starting with a pre-auth and finishing up later, you won’t pay interchange fees until the actual authorization goes through and the customer’s card is charged.

So if that transaction is canceled for any reason, you don’t have to lose out on any interchange fees — only the payment gateway fee.

Eliminates most refund fees

Refund fees are common in the payment processing world, and it’s ideal to avoid paying these fees whenever possible. If you need to cancel a pre-authorization for a customer, there’s no refund penalty associated with that because the funds were never actually withdrawn. This is super useful for clothing businesses or anyone that deals with fast returns frequently.

Reduces merchant-caused refunds

We all know that it isn’t the customer who always issues the refund. If you’re out of stock, that stinks because you have to issue a refund and disappoint a customer. So anything that you can’t deliver for whatever reason won’t be subject to interchange or refund fees.

Can be used as a payment guarantee of sorts

By including language like “Your credit card will not be charged until your order has been mailed”, you can potentially increase conversion rates.

What to do if your Pre-Auth Expires

Run it again! Since funds were never actually charged, charging your customer’s card for the price won’t feel like an additional charge or anything like that. It may take a few more days, but that’s the only risk!

It’s pretty obvious to see why pre-authorizations can be a valuable tool for businesses — especially those with a higher-than-average return or chargeback rates.

To learn more about setting up pre-authorization capability on your POS system or payment gateway, please feel free to cotact us.

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