A pre-authorization charge is a temporary hold placed on a customer’s debit or credit card to ensure they have sufficient funds for an upcoming transaction. These charges help protect both businesses and customers by preventing fraud and unexpected charges, enhancing the payment process, and increasing trust from both parties. 

In this article, we’ll explore what a pre-authorization charge is and how it works, the advantages of using pre-authorizations, and the types of businesses that can benefit the most.

What is a pre-authorization charge?

A pre-authorization charge, also known as a ‘pre-auth’, is a temporary hold placed on a customer’s debit or credit card to verify they have sufficient funds or credit available for an upcoming transaction. This happens without actually debiting the account upfront, although available credit is temporarily reduced to prevent the customer from using that money elsewhere. 

Pre-authorization charges are often used in situations where the final amount isn’t known at the time of the initial transaction, such as hotels, car rental companies, and gas stations. Once the final transaction amount is determined, the merchant either completes the charge for the actual amount or releases the hold if no purchases are made. Pre-authorizations help protect businesses against fraud and guarantee they’ll be paid for the services rendered or products provided. 

Here’s an example of pre-authorization in action: 

A guest books a hotel for $500 for five days. During their stay, there’s a chance they’ll purchase extra add-ons, like room service or items from the minibar. To account for the potential extra costs, the hotel places a $650 authorization hold on the guest’s card. This reduces the guest’s credit limit by $650. When the guest checks out, their bill comes to $585. Because the funds have already been reserved, this amount is automatically debited and the remaining difference is released back to the guest’s account. 

How pre-authorization charges work

For businesses, pre-authorization provides a peace of mind by ensuring a customer’s card has sufficient funds for an upcoming transaction. This is especially important when the final charge amount isn’t immediately known. To help you better understand the process, here’s how pre-authorization works:

Initiating the pre-authorization

Pre-authorizations start when a customer uses their card for a transaction where the final amount isn’t known upfront. As the business, you’ll input the estimated amount for the service or purchase into the payment system and send a pre-authorization request to the cardholder’s bank or card issuer.

Holding the funds

Next, the card issuer verifies the cardholder’s account to ensure they have sufficient funds or credit available to cover the pre-authorization amount. If funds are available, and the card passes additional security and fraud checks, the pre-authorization request is approved. This holds the approved amount and temporarily reduces the cardholder’s available balance. If the cardholder has insufficient funds, the pre-authorization will be declined.

Submitting final transaction amount

When the final transaction amount is known (e.g, the customer checks out of their hotel), you will submit the actual charge and complete the transaction. The card issuer releases the pre-authorization hold and replaces it with an actual charge for the final amount.

Releasing unused funds

If no charge is made, or the actual transaction amount is less than the pre-authorized amount, the hold on the unused funds is released. This restores the available balance to the cardholder.

How long does a pre-authorization last?

Pre-authorization charges on credit and debit cards usually last for five to seven days, although the duration can vary depending on various factors: 

• Merchant Classification Code (MCC): Depending on your Merchant Classification Code (MCC), you could release a hold as soon as the transaction is completed or hold the funds for a longer duration. If your business is regularly processing pre-authorizations for periods longer than five days, you may want to contact your credit card processor to have your MCC reassigned.  
• Card issuer policies: Different banks and card issuers have varying policies on how long they maintain the hold. Some banks keep pre-authorizations held for up to 14 days. 
• Type of transaction: Certain transactions, like long-term hotel stays or car rentals, can have longer pre-authorization periods to accommodate potential damages or additional charges. These can last up to 31 days.

Benefits of pre-authorization for businesses

There are several reasons why pre-authorization can be beneficial for businesses and customers. They provide a financial safety net, improve the customer experience, reduce lost revenue to fees and late cancellations, and improve trust for both customers and businesses. 

Let’s look into the benefits of pre-authorization holds below: 

Improved customer experience

Pre-authorization can create a smoother and more transparent customer experience. By informing customers upfront about the pre-authorization hold, businesses set clear expectations about potential charges. This makes both sides feel more relaxed and reduces the risk of doubt and mistrust, which is especially important in industries where the final bill might differ from the initial estimate. 

By helping businesses provide a more accurate estimate of the final cost of goods or services, pre-authorization also prevents surprises at checkout and reduces the likelihood of disputes over unexpected charges, leading to higher customer satisfaction and trust. 

Assurance that businesses are paid 

Pre-authorized payments provide peace of mind to businesses by ensuring customers are able to pay for the service or product. By setting aside the estimated payment amount from the beginning, businesses reduce the risk of non-payment or default. 

Reduced risk of fraud

Businesses using pre-authorization can minimize the risk of fraud by verifying whether a customer’s credit or debit card is valid before finalizing the sale. During the pre-authorization process, the card issuer checks the card details and customer’s account status and flags any suspicious activity or potential fraud. This ensures that the card being used is legitimate and belongs to the authorized cardholder, protecting businesses from fraudulent activities.

See more: Types of Payment Fraud and How Businesses Can Prevent Them

Reduced risk of lost revenue

In industries that rely on reservations and bookings, such as hotels, airlines, restaurants, and car rental agencies, pre-authorization helps confirm a customer’s commitment to showing up. This reduces the risk of no-shows and cancellations without prior notice, helping businesses better manage their inventory and resources while also preventing lost revenue due to last minute cancellations. Many businesses choose to charge a no-show or late cancellation fee which is automatically deducted from the pre-authorized amount. 

Minimized chargebacks

Charbacks happen when customers dispute a transaction and request a reversal from their bank or card issuer. For businesses, chargebacks can lead to lost revenue, time & resources managing disputes, and a damaged reputation. 

Usually, chargebacks involve a dispute resolution process where the business needs to provide evidence that the customer approved a transaction. This is where pre-authorizations can be useful. Because the pre-authorization process verifies the cardholder’s consent to the transaction, it can be more difficult for customers to claim that a charge was unauthorized. It also makes it easier for businesses to provide evidence that the customer approved the transaction. 

Learn more: Chargeback vs Refund: What’s the Difference?

Flexibility to handle additional charges

Pre-authorization gives businesses more flexibility to handle additional charges that might arise during the service period. For example, a hotel can add charges for room service or minibar usage, and a car rental company can include extra fees for late returns or fuel. Since the pre-authorization hold can cover an estimated amount that accounts for such incidental expenses, businesses can process these charges without needing further approval from the customer. This simplifies the billing process and ensures charges are settled promptly. At the same time, it reduces the need for customers to provide their payment details more than once, which can be frustrating.

Better cash flow management

By placing a pre-authorization hold on a customer’s funds, businesses can ensure that the money for a sale or service is reserved and will be available when the final transaction is processed. This helps manage cash flow more effectively as businesses can rely on receiving the expected payment without delays. For example, hotels can secure payment for a room reservation or car rental companies can guarantee funds for the rental period. This assurance makes it easier for businesses to plan and forecast receivables more accurately.

Reduces payment processing fees

Another benefit of pre-auths is that a business won’t incur payment processing fees until the final charge is processed. This is useful in situations where a customer may request a refund, a sale is canceled, or a business wants to automatically process payments before determining whether they can fulfill an order. In these situations, if a customer was charged and then requested a refund, the business would pay fees on both sides of the transaction (i.e. when processing the initial payment and when processing the refund). With pre-authorizations, on the other hand, a business can cancel the payment with no fees. 

Here’s an example: If you run an online store and receive an order for an item that you don’t have in stock, you can simply release the funds from the pre-auth instead of needing to refund the customer’s credit card and pay refund fees.

Continue reading: What Are Payment Reversals and How to Avoid Them

Which businesses should use pre-authorization?

Certain businesses are more likely to benefit from using pre-authorization holds. This includes companies selling high-value products, businesses that deal with reservations or offer services that may incur additional charges, and businesses that want to avoid chargebacks. We recommend using pre-authorization if your business is related to hotels & hospitality, car rental agencies, bars & restaurants, ecommerce & online retail, or gas stations.

Here’s how pre-authorization can help each of these businesses.

Hotels & hospitality

It’s common in the hotel industry for guests to incur additional charges beyond their initial booking, such as room service, minibar usage, or damages to the room. Pre-authorization guarantees that funds are available to cover these incidental expenses, reducing the risk of unpaid charges and disputes at checkout. 

Car rental agencies

Companies that offer car rental services can benefit from pre-authorization by providing a security deposit for the rental period, potential damages, fines, fuel charges, and any extra fees for late returns. Because car rental is such a high-risk service, pre-auths can mitigate the risk of financial losses and ensure a smoother transaction experience for both the company and customer.

Restaurants & bars

Establishments that allow customers to run tabs or make reservations for large groups of people can use pre-authorization to confirm that funds are available to cover the final bill. This reduces the risk of unpaid tabs and no-shows, protecting these businesses from lost revenue. 

Ecommerce & online retail

Online businesses, especially those that sell high-value items, offer pre-orders, or provide long shipping periods, can use pre-authorization to ensure customers have sufficient funds before shipping products. This benefits both merchants and customers:

• Pre-auths can improve customer satisfaction by protecting them against delayed or incorrect deliveries. The customer will only be charged when the product has been delivered, and if an item is not in stock their funds will be released faster than if a refund was issued. 
• For businesses, this reduces the risk of chargebacks and fraud, providing more secure transactions, and improving the customer experience. 

See more: Ecommerce payment methods: what they are and how to choose the right ones

Gas stations

Many gas stations use pre-authorization holds to ensure customers have enough funds to cover the fuel they purchase. This is especially important for pay-at-the-pump services, where the exact amount isn’t known until after fueling. 

Summary: What is a pre-authorization charge?

You don’t have to be in the aforementioned industries to benefit from payment authorizations. No matter what type of business you run, incorporating pre-auths into your operations can help reduce chargebacks, payment disputes, and fees associated with refunds. This not only benefits you as a business but also your customers, helping increase satisfaction and trust.

At ZEN.COM, payment authorization charges are just one of the features we offer as part of our online payment solutions. With ZEN, you also get instant settlement, the lowest processing fees, 20+ payment methods, and a seamless checkout experience that reduces abandoned carts and increases your conversions. Start by telling us about your business and we’ll match an account to meet your needs.