What Is a Pre-Authorization Charge on a Card?

What Is a Pre-Authorization Charge on a Card?

A pre-authorization charge is a tool merchants in certain sectors use to ensure customers have enough money to pay for goods and services. When used correctly, this tool can protect merchants and reduce fees. When used incorrectly, it can lead to customer frustration and negative reviews on social media.

If you are a business owner who accepts credit or debit card payments—or even one who deals purely in cash—understanding how pre-authorizations work and best practices when placing a pre-authorization charge can help you ensure full payment from customers without causing confusion and risking bad reviews.

What Is a Credit Card Pre-Authorization Charge?

A pre-authorization charge is a hold that a merchant places on a customer’s credit card for a certain amount of money to ensure they have sufficient funds to pay for goods or for a service that hasn’t yet been finalised. During the time that the amount is reserved, the customer can’t withdraw these funds or spend them on something else.

Once the merchant is ready to charge the card, he or she submits the actual transaction amount, at which point the funds are debited from the customer’s account and settled to the merchant’s account with the next batch of transactions. Merchants usually have between one and 30 days to process the transaction, depending on their Merchant Classification Code (MCC). After the holding period, any pre-authorized funds that weren’t debited by the merchant are released back to the customer.

Industries That Use Pre-Authorizations

Any merchant can place a pre-authorization hold on a customer’s credit card after opening a merchant account. However, there are certain industries that use pre-auths as standard practice:

  • Restaurants often use pre-authorizations to ensure customers can add a tip to their credit card bill without having to provide their card or card details again.
  • Rental companies use pre-authorizations to reserve a security deposit in case there is any damage to the item that was rented out.
  • Car rental agencies use pre-authorizations to reserve enough funds to cover petrol refills, tolls, parking fines and damage to the vehicle.
  • Hotels use pre-authorizations to ensure that the customer has enough money to cover the fees for their stay plus room service, any items taken from the mini-bar and any damage to the room.

In addition to these common scenarios, there are other cases in which a merchant might place a pre-authorization hold rather than charging a customer’s credit card immediately:

  1. A customer orders an item that’s currently out of stock.
  2. A customer places an order to an unusual address, for which shipping must be calculated after the fact.
  3. A customer places a custom order.
  4. A merchant offers a satisfaction guarantee. (Merchants can only use a pre-authorization for this if they have permission to hold funds for the length of the return period).

Basically, if the exact transaction amount isn’t yet known or if there’s a high likelihood of cancellation or return, a pre-authorization charge can be used.

Benefits of Pre-Authorizations for Merchants and Customers

For merchants, there are several benefits to the pre-authorization process:

  • The merchant knows there are sufficient funds in the customer’s account (or the customer’s credit limit is sufficient) to cover the cost of services before they are rendered.
  • The merchant doesn’t have to ask for the customer’s card details again for additional charges.
  • If the service is cancelled or goods are returned, the merchant can simply cancel the pre-authorization rather than pay transaction fees twice—a payment gateway fee for the initial transaction plus refund fees on the other end.

For customers, pre-authorizations also have advantages:

  • The customer doesn’t accidentally spend the money for a contracted service on something else.
  • The customer’s money is released as soon as their card is charged or the pre-authorization period is over. This is significantly quicker than the time it takes to process a refund.

Best Practices When Using Pre-Authorizations

To ensure maximum customer satisfaction and prevent misunderstandings and negative reviews, it’s essential to communicate very clearly with customers about the pre-authorization process and what to expect.

  1. Let the customer know beforehand that you’re placing a pre-authorization charge on their credit card for a certain amount and how long the hold will be in effect.
  2. Make your soft billing descriptor abundantly clear with your “doing business as” name, the length and amount of the hold and who the customer can contact with any questions. This prevents any surprises when the customer receives his or her credit card statement.
  3. Depending on your Merchant Classification Code and how long you reasonably need pre-authorizations to last, talk to your credit card processor about increasing your pre-auth holding time. A hotel owner, for example, might typically need to hold funds for two weeks rather than only a few days.

How to Set Up Pre-Authorizations

To start using pre-authorizations, talk to your merchant services provider about adding this option to the settings in your global payment gateway. If you don’t yet have a merchant services provider and want to start using pre-auths, look for a provider that offers merchant services including fraud protection and chargeback mitigation tools to prevent losses from bad actors.

Get the Most From Pre-Authorizations

When used properly, pre-authorizations can help you reduce losses from no-shows, damages, and product returns. A pre-authorization charge is easy to make once the system is set up, and using this tool can help you prevent losses and process transactions for which you don’t yet know the exact amount. While you won’t get paid for services up-front, it’s usually worth the wait to avoid underpayment and refund fees.

If you decide to use pre-auths, talk to your payment processor about configuration and holding times and communicate with your customers every step of the way. As long as you keep your customers in the loop and have an appropriate holding time, you’ll save money and stop losing revenue from no-shows and customers who drive off without paying.