Using Pre-auths to Reduce Chargebacks

An authorization hold, also known as a pre-authorization or a pre-auth, is when money on a customer’s credit or debit card account is held frozen until the merchant settles the transaction or the hold is cancelled or expires. The time between authorization and settlement can be a few seconds or as long as 31 days, depending on the Merchant Category Code (MCC). In some MCCs, pre-auths are used as a form of a safety deposit to make sure the customer can cover all anticipated charges.

For example, pre-auths are commonly used in the hotel industry, where the merchant wants to know the customer has a valid method of payment and sufficient funds to cover the cost of the stay and any incidentals that might be incurred. Another vertical where using pre-auths is common is car rentals. The rental agency doesn’t know in what shape the car will be returned and if the gas will be filled, so it places a pre-auth as a security deposit to ensure there is money to cover any additional costs that might arise. If there are no issues with the car, then a final sum less than the initial pre-auth is captured in settlement.

In eCommerce, using a pre-auth with delayed capture enables merchants to tell their customers that their card won’t be charged until their order is shipped while verifying for the merchant that they will get paid by the customer. It also saves the merchant from having to engage in the hassle and additional processor fees for issuing refunds. 

In the case of fraudulent orders, pre-auths can also be helpful. When a cardholder sees a pre-auth on their account for a transaction that they didn’t authorize, they can call the merchant during the pre-auth period to have it cancelled. Besides preventing a fraud chargeback, a cancelled pre-auth in this case also benefits the merchant because it is also much less likely to generate a TC40/SAFE report from the issuing bank. The TC40/SAFE reports are how the card networks calculate a merchant’s fraud ratio for monitoring purposes. 

Pre-auths can be a useful tool for merchants to prevent chargebacks in a number of ways. We’ve already mentioned that it gives you and the cardholder more time to catch fraudulent transactions and cancel them, avoiding a chargeback. Pre-auths also allow the merchant to locate and address problems in order fulfillment like an accidental double charge or an order for out-of-stock inventory to cancel these orders before they become chargebacks.

However, pre-auths can also lead to more chargebacks if not used carefully. For example, a transaction can be disputed if you don’t settle it within the time limit. You could also receive a chargeback if the transaction amount captured at settlement is more than the authorized transaction amount. That means you need to be careful in how you use pre-auths.

Your customers may also be confused by pre-auths. If they see an authorized amount that is different from the transaction amount they may get worried and call either you or their issuing bank. That is why it is always important that you communicate clearly with customers what you intend to do when placing an authorization hold on their card.

Just like with chargeback prevention, using pre-auths effectively requires that good customer service practices be in place.

Authorization holds are not indefinite. For most eCommerce merchants, the maximum a credit card pre-auth can last is seven days. For those in either the travel or entertainment sectors, including hospitality and vehicle rental, the maximum hold on a credit card can be as long as 31 days. The exact length of time that you can apply for an authorization hold will be determined primarily by your MCC with the credit card brand. Most debit card transactions have a hold of one to eight business days.

Pre-auths cancel automatically after they reach their time limit, but it’s important to cancel the authorization or capture the funds within the time limit. If you do not settle charges in  time for an excessive number of pre-auths, you may be hit with what Visa calls a “Misused Authorization Fee” and MasterCard refers to as a “Processing Integrity Fee.” Whatever the name, Visa or MasterCard imposes the fees for authorizations that are not settled or reversed within the given timeframe as a way of preventing abuse of the system.  

Using authorization holds to reduce chargebacks can be a tricky business. That doesn’t mean you shouldn’t consider using them as a merchant, especially if you have a lag between when you authorize a payment and when the bill is settled. If you need help making sense of your chargeback prevention strategy and where pre-auths fit into it, contact us at Justt.