Pre-Authorization Settlement is Essential for Some Credit Card Transactions
Pre-authorization settlement can be an essential process for some merchants who accept credit cards. However, both cardholders and merchants can sometimes be a little unclear on what this refers to, and why it matters.
In this post, we’ll examine pre-authorization settlement, what it does, and how you should handle the process to avoid problems. First, though, it’s important to understand what pre-authorizations are and when you should use them.
What is a Credit Card Pre-Authorization?
When a cardholder swipes or dips a credit or debit card, the purchase information gets routed to the issuer, who provides authorization for the transaction. This process doesn’t transfer funds from the cardholder to your bank account. Instead, it’s simply the bank’s way of telling you as a merchant that the funds for a purchase exist.
So, a pre-authorization—also known as an authorization hold—is a practice by which the card issuer allows you to place a hold on an amount approved as part of a transaction. The bank essentially holds that part of the customer’s balance in reserve for a few days until you clear the transaction. You can use pre-authorization to ensure that you actually get paid for purchases made via a payment card.
You’d typically submit transaction settlements in batches, rather than submitting them one at a time. Thus, the whole process can take several days before the bank releases the hold and transfers the funds.
Remember, though: you must submit the transaction for settlement within the time frame allowed by the card network. Otherwise, the bank may reject the transaction, or file a chargeback (likely using Visa reason code 12.1 – Late Presentment or Mastercard reason code 4834 – Late Presentment).
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How Does Pre-Authorization Settlement on a Credit Card Work?
- Pre-Authorization Settlement
A pre-authorization settlement occurs when an issuing bank deposits funds into a merchant’s bank account after that merchant has deployed a pre-authorization during a transaction. This is often done because the final total for a transaction is unknown at the time of purchase.
[noun]prɪ ● ɔ ● θɚ ● rə ● zeɪ ● ʃən
As outlined above, pre-authorization settlement occurs when the issuer deposits the preauthorized funds into your bank account.
Not every merchant uses pre-authorizations. However, In some business verticals in which they’re standard practice, such as hotels, restaurants, and gas stations. This is because the total amount of the transaction may be unknown at the time that authorization is requested.
To illustrate, let’s say you run a restaurant. A customer wants to pay for a meal using a credit card, so you might swipe the customer’s card, requesting a pre-auth for the approximate cost of the meal. The customer can then leave a tip, which you include in the final cost of the ticket submitted to your processor. It’s then the processor’s job to submit that final total to the issuer for payment.
Settlement is a function is handled largely by your acquirer. As a merchant, you don’t need to do much beyond request the pre-authorization hold, then make sure you submit the transaction for settlement in a timely manner.
Perks & Pitfalls of Pre-Authorization Settlement
There are many reasons why you would request a pre-authorization as part of the transaction process. Pre-authorization settlement allows you to:
Ensure That Customers Pay for Goods & Services
You don’t have to worry about a customer disappearing without paying, even if the final total is unknown at the time of purchase.
Lower Your Fees
Many issuers charge an MDR (merchant discount rate) fee for authorized transactions. They may skip this fee for pre-authorizations, though.
Provide Better Customer Service
If a customer needs to reverse a purchase, it’s a lot easier to cancel a pre-authorization than to refund a finalized transaction.
Skip Refund Fees
Your processor may charge a fee to process a refund. With a pre-auth, though, you don’t have to submit a refund, which means you don’t pay that fee.
Cardholders can’t dispute pre-authorizations; the buyer can’t turn around and submit a chargeback request until after pre-authorization settlement.
All that said, the pre-authorization settlement scheme is not perfect. For instance, it’s known to cause confusion among cardholders, especially as regards the time frame for transaction finalization.
Different parties all set their own time limits on how long a hold can last. Time frames can also vary based on the type of card used. Some industries have their own unique time limits: hotels, for instance, can place a hold on a customer’s card for the duration of that guest’s stay. The merchant can then tabulate the guest’s expenses to produce a final charge, which is summited for the pre-authorization settlement.
Cardholders, however, don’t know what goes on behind the scenes. When buyers see holds on their account, they tend to assume the merchant—not the bank—is holding their money. If the hold remains in place longer than anticipated, the cardholder might get angry and complain, or voice their frustration on social media.
Best Practices for Pre-Authorization Settlements
So, what can you do to ensure that you don’t run into trouble? Well, here are a few best practices we recommend that you adopt in order to insulate yourself against risk:
Communicate With the Customer
Explain the pre-authorization to your customer at the time of purchase, so they know why their money is being held. Include a timeframe in which to expect settlement.
Submit Transactions in a Timely Manner
Don’t wait more than five days to submit pre-authorizations to the bank. If they expire, the funds will be returned to the cardholder.
Don’t Submit Multiple Requests
If a pre-authorization times out or another issue arises, contact the cardholder before submitting another authorization. Doing otherwise could lead to a chargeback.
Optimize Your Soft Billing Descriptor
The descriptor appearing on your customer’s statement should clearly communicate who you are, why their funds are being held, and how to contact you in case of questions.
Make it Easy to Reach Out
Maintain open communication across all customer service channels, with live service to answer customers’ questions. Respond to all phone, email, and social media inquiries as soon as possible.
In this post, we examined credit card pre-authorizations and pre-authorization settlement. We looked at how these two processes work, as well as common mistakes to avoid and best practices to adopt.
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What is a pre-authorization settlement?
Pre-authorization is the act of “locking in” funds in the cardholder’s account for a transaction (even if the exact amount is not known). Pre-authorization settlement is simply settling those accounts with the bank, and securing those funds.
Is there a time limit to settle pre-authorized transactions?
Yes, typically 5 days.
What happens if I miss the pre-authorization settlement deadline?
The pre-auth will expire, meaning the hold on the funds will be released by the issuer. There may be an opportunity to re-charge the amount to the card. In some cases, however, the issuer will file a bank chargeback, meaning you have lost the funds for good.
Do all businesses use pre-authorization?
No, but they’re standard practice for some business verticals (hotels, restaurants, gas stations) where the total amount of the transaction may be unknown at the time of authorization.