4 min read

What Is a Pre-Authorization Charge

Have you ever wondered why car rental companies or hotels might ask for your credit or debit card and then put a hold on funds before you've even taken the keys or checked into your room? This process, known as a pre-authorization charge or 'pre-auth,' is a common yet often misunderstood aspect of modern transactions.

Why do businesses place these holds on your account? Do these pending transactions on credit cards reflect on the statement? What does it mean for your available balance when placing a security deposit without an immediate purchase?

Pre-auth charges are a security measure for both the provider and the customer, ensuring that the transaction amount won't exceed the available funds.

But how does this affect your experience with car rental agencies, hotels, and other service-based industries? And what rights do you have as a consumer regarding these holds on your funds?

Dive deeper into the world of pre-authorization charges with us. Discover the mechanics behind this financial practice, its implications for your credit or debit card, and how it benefits both the customer and the business.

Defining Pre-Authorization Charges

Pre-authorization charges are a fundamental aspect of credit card processing, where a payment processor temporarily holds a specified amount of money on a credit or debit card.

This hold, often called 'pre-auths' or 'pre-authorized funds,' does not represent an actual charge but indicates reserved funds for a future payment. The process is a cornerstone of electronic payment processing, ensuring the transaction can go through once the final amount is determined.

Example of Pre-Authorization on Customer’s Credit Card

To make this more relatable, imagine you're dining at a restaurant and deciding to pay with one of your credit cards, especially if it's a credit card for people with bad credit.

After you hand over your card, the restaurant's payment processor might initiate a pre-auth for the estimated bill amount. This doesn't mean your card has been charged immediately.

Instead, these pending transactions on your credit card signify the restaurant has verified that the funds are available, thus reducing the risk of the credit card being declined when the final bill, including any tips or additional charges, is processed.

This pre-authorization process safeguards both the merchant and the customer. It ensures that businesses can provide services with the confidence that payment will be received, and customers are assured that only the actual charge for services or products received will be deducted from their accounts.

How Pre-Authorization Works

Let’s explore how pre-authorizations work:

The Process of Pre-Authorizing Payments

Pre-authorizations start when a merchant initiates a credit card transaction, specifically requesting to hold a certain amount of funds. This request is sent through their payment gateway to the bank that issued the customer's credit card.

The bank then temporarily holds the requested funds, ensuring they are available for the eventual charge. This process is vital for transactions where the final amount might vary, such as merchant classification code-specific purchases.

Credit Card Processor and Payment Gateway Fee Implications

Merchants must consider the costs and pre-authorization charges associated with credit card processing. Some banks charge electronic transfer fees for each transaction processed through their systems.

The merchant account may incur fees from the payment gateway for handling the pre-authorization process. Additional fees can vary based on the merchant's agreement with the payment processor and the type of transaction being processed, such as a deposit on a secured credit card.

Pre-Authorization Hold: Pending Transactions Explained

When accepting payments via credit card transactions, merchants often pre-authorize a temporary reserve on the customer's account. This process, known as a pending transaction, ensures sufficient funds are available to cover the final cost of the service or product.

Ensuring Sufficient Funds

The main objective of pre-authorizations is to ensure that the account holds enough money to complete the purchase, safeguarding both the customer and the merchant.

Expiration of Pre-Authorizations

Pre-authorizations typically expire if not converted into a full charge within a set period. This duration can vary depending on the merchant's policies and the nature of the transaction.

By pre-authorizing a specific amount, merchants temporarily reserve funds to cover the anticipated bill, ensuring that the final transaction goes smoothly without hiccups related to payment acceptance.

Benefits of Pre-Authorization Charges

Pre-authorization charges benefit merchants and customers by streamlining transactions and enhancing payment security. By putting funds on hold, these charges help manage financial expectations and obligations more efficiently.

The advantages for merchants include:

  • Risk Reduction: Ensures the cardholder's account has sufficient funds, reducing the risk of failed payments.

  • Cash Flow Management: Helps forecast and improve cash flow by securing funds for services rendered or goods delivered.

  • Customer Trust: Demonstrates to customers that charges will be for the actual amount spent, enhancing trust.

  • Chargeback Mitigation: Pre-authorizing payments significantly diminishes the likelihood of chargebacks. Since the transaction is not final, there's no basis for raising a chargeback, safeguarding against disputes before they happen.

  • Minimizing Merchant Fees: With pre-authorization, merchants can bypass certain fees associated with completed transactions. Specifically, merchant discount rate (MDR) fees are not applied until a transaction moves beyond the pre-authorization stage.

  • Reducing Refund Costs: Engaging in pre-authorizations allows for a straightforward cancellation process if the deal doesn't go through. This approach sidesteps the need for refunds and, consequently, the fees typically charged for processing them, offering a cost-effective solution for managing potential transaction reversals.

Meanwhile, there are several additional benefits for customers:

  • Transparency: Pre-authorization reduces surprises for the customers.

  • Financial Planning: Helps customers manage their finances better by showing on-hold funds, allowing them to anticipate and plan for expenses accordingly.

  • Protection: Ensures that only the standard payment is deducted, with the card issuer offering oversight.

Pre-authorization charges thus play a pivotal role in ensuring a smoother, more predictable transaction process for all parties involved.

Applications of Pre-Authorization in Various Industries

Pre-authorization charges are a versatile tool used across a wide range of industries to secure payments and manage transactions efficiently. Their application spans sectors where the final cost may vary or a deposit is necessary for guaranteed service.

Here's a glance at some industries leveraging pre-authorization:

  • Hospitality (Hotels and Resorts)

  • Car Rentals

  • Healthcare Services

  • Online Retail and E-commerce

  • Subscription Services

  • Event Ticketing

  • Restaurants and Dining

  • Travel and Airlines

Best Practices for Merchants Using Pre-Authorization Charges

Efficient use of pre-authorization charges demands strategic management to prevent disputes and enhance customer relations. Below are streamlined strategies for merchants.

Inform Your Customers

Make sure customers understand the pre-authorization process, including why funds are being held and when they'll be released or charged. Clear, upfront communication can prevent confusion and foster trust.

Process Transactions Promptly

Avoid letting pre-authorizations expire by finalizing transactions within the agreed timeframe. This ensures a seamless transition from hold to charge, securing sales effectively.

Use Clear Billing Identifiers

Ensure billing statements clearly identify the merchant, the reason for the hold, and contact information for inquiries. Transparency in billing helps reduce customer anxiety and improves satisfaction.

Keep Communication Lines Open

Be available to address any customer queries about pre-authorizations. Prompt and clear responses can enhance the customer experience and encourage loyalty.

Final Thoughts

The effective management of pre-authorization charges is critical for merchants navigating the realm of online payments and rental services. Integrating such practices within shopping cart software or managing rental periods becomes seamless when understanding the interplay between a customer's credit limit and a merchant's account.

Clear communication of payment information and the provision of official confirmation optimize the transaction process and ensure that both parties are informed and confident in the transaction's integrity.

By adopting these strategies, merchants can enhance service delivery, safeguard financial transactions, and foster a trustworthy relationship with their customers, ultimately contributing to a smoother and more reliable online shopping experience.

Note: KOHO product information and/or features may have been updated since this blog post was published. Please refer to our KOHO Plans page for our most up to date account information!

Nick Saraev

Nick is a freelance writer and entrepreneur with a particular interest in business finance. He's been featured in publications like Popular Mechanics and Apple News