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How Do Pre-Authorizations Work?

November 5, 2019

How Do Pre-Authorizations Work?

November 5, 2019

Credit card pre authorization is an important and useful practice for merchants accepting payments in person or online, and offers many benefits. With pre-authorization of payments, merchants ensure their customers pay for the products and services they use. Merchants also save time and money by eliminating the instance of fees for refunds, MDRs, and the hassle of processing chargebacks. But, how do they work? 

If you’re not sure what a pre authorization is, or how the process works, you’re not alone. Many merchants aren’t familiar with pre-authorizations and are hesitant to use them. Read on for an overview of what preauthorization is, and the ways it can benefit your business. 

What is a pre-authorization?

A pre-authorization is essentially a temporary hold placed by a merchant on a customer’s credit card, and reserves funds for a future payment transaction. This hold typically lasts about five days, though this depends on your MCC (merchant classification code). 

During the hold period, the funds are unavailable to the customer – they won’t be able to withdraw it from an ATM, or to spend it elsewhere. Although the funds cannot be accessed in their account, no money has been debited in the pre-auth, it is simply reserved. When the time comes to finalize a payment – for example, checking out of a hotel – the funds on hold can then be “captured”, meaning they are converted to a charge. 

When are pre-authorizations used?

Hotels are one of the primary industries where pre-authorizations are commonly used. Pre-authorized payments for hotels enable funds to be held either at the booking stage, or during check in. This helps to guarantee that, when the time of check out comes, there are funds available to cover additional charges incurred during the guest’s stay. Room service, spa visits, or damage to the room can be covered by these reserved funds. By placing a hold on extra funds, hotel managers can rest assured that a guest cannot leave without paying. 

When a guest checks out of your hotel, the hold is converted into a charge. If the guest prefers to pay with a different card or payment method, the pre authorization is cancelled and the funds on hold will be released within a few days. 

Car rental agencies also commonly use pre authorizations with their clients. By placing a hold on funds when the car is rented, agencies can be sure that the car will be returned in good shape, with a full tank of gas. If there is damage to the car or a need for fuel, the hold will cover these charges. 

Tour operators and activity providers also utilize pre authorizations. For those lending customers expensive pieces of equipment, such as a bicycle or surfboard, the funds protect them from being stuck with the costs associated with loss, damage, or theft. In these cases, the hold is also referred to as a “security deposit”. 

The pre-authorization process

For merchants using a turnkey payment solution, processing a pre-authorization is very easy. In the case of online payments, there are two simple steps: 

  1. Setup your online site to accept pre-authorizations instead of full authorizations.

Your shopping cart software should include an option where you can choose to process pre-authorizations. Then, when a customer makes a booking through your online site, the transaction will be processed as a pre-authorization, and a hold will be put on the customer’s funds. 

For merchants with an online presence who are accepting payments through their site, it is essential to begin with setting up the shopping cart options to support preauthorizations. The shopping cart you are using should have this option available. Once activated, customers making a booking through your site will be processed as a pre-auth, and a hold will be placed on the necessary funds. 

  1. Capture the funds.

Capturing the funds is a function of your credit card processing platform. During this stage of the process, the hold on the funds will be converted to a charge. It may also be possible for you to capture these payments from within the shopping cart software interface. 

For merchants accepting payments over the phone via a virtual terminal, the terminal itself should display an option to select either authorization or pre-authorization. After selecting “pre-authorization”, the process is the same as always: enter the customer’s card details as you would for any standard payment, and confirm it with the customer. Be sure to remember to capture the funds through an authorized payment later, when the time comes. 

For merchants, there are two very important best practices you should take into account to be sure that the pre authorization process goes smoothly for both you and your customer: 

  1. Explain the pre-authorization charge to your customer. Tell them that you are holding funds on their card, and the amount that will be reserved. Check to be sure they understand how long the pre authorization charge will last. 
  2. Be sure to capture the fully authorized payments before the fifth day, while the funds are still being held in the customer’s account. After expiry, the pre authorized funds will be released back to the cardholder, and will be available to be withdrawn or spent. Be sure to avoid this, as you would then have to contact the cardholder to process a new payment in order to hold funds again. 


What are the benefits of pre-authorization?

There are many benefits to pre authorization. Merchants can reduce their fees, while also providing customers with a positive experience. Here are some of the main benefits to both you and your customers: 

1.      Ensures customers pay for their services. 

By putting a hold on customer funds, you never have to fear that a customer will leave without paying for the services they used. 

Instead of worrying that a customer will leave without paying for the services they’ve used, place a hold on the funds and ensure that all incidentals and additional charges will be covered. 

2.      Avoids chargebacks. 

Pre authorized payments are amongst the easiest ways to prevent chargebacks. If funds have not yet been captured, the cardholder cannot issue a chargeback, as it is not a confirmed charge open to dispute. 

3.      Avoids MDR fees. 

Many issuers of credit cards charge an MDR (merchant discount rate) fee only when a transaction is fully authorized. 

4.      Avoids refund fees. 

Many credit and debit card processors apply a fee for refunded charges. If the payment hasn’t been captured and processed yet, you can simply cancel the hold and no refund is needed – because the payment was never completed – so no fees will be incurred. 

5.      Improves customer satisfaction. 

In some cases, you may find you need to cancel a customer’s bookings or reservations after they have been confirmed. If a customer has already paid for the booking, this can make them unhappy, as they will need to wait for the funds to be returned to their account. When using pre authorizations, there is no payment to refund, the hold is simply canceled. 

Overall, the process of accepting pre authorized charges is easy, and provides merchants with a slough of benefits, including reducing costs and gaining happy customers. It is a simple yet valuable practice that all merchants should leverage in their business for payments made online, in store, over the phone, or via mobile. 


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