Pre-Authorization Charges: What eCommerce Merchants Need to Know

Chargeback claims increased by 6% from 2022 to 2023, with projections indicating chargeback transaction volumes surge to 337 million by 2026.

These growing numbers are a wake-up call for businesses facing payment disputes, fraud, and lost revenue. One viable solution is pre-authorization charges. Think of them as a safety net that catches potential failed payments before they happen.

Placing a hold on funds upfront helps ensure your customers have enough funds in their accounts to cover their purchases. This can minimize chargebacks and eliminate the uncertainty around whether a transaction will clear.

Here, we go in-depth about pre-authorization charges, their benefits, why they matter, and more.

What Is a Pre-Authorization Charge?

Pre-authorization charges are temporary holds merchants place on a customer’s payment method. This makes sure the funds are available for a transaction.

As a merchant, these charges can impact how you manage your finances, particularly cash flow and available credit.

How Does Pre-Authorization Work?

When a customer makes a purchase, your payment processor requests a pre-authorization hold from the customer’s bank or credit card issuer. This temporarily locks down a portion of the customer’s available credit, which confirms their ability to pay.

However, the system only charges the actual transaction amount after you render the service or deliver the product.

So, the hold doesn’t immediately charge the customer’s account. Instead, it reserves a portion of its available credit for funds for a specific period while you process the transaction.

Let’s take a look at the steps of pre-authorizations in action:

1. Customer initiates the purchase: When a customer makes a purchase, especially for services or high-ticket items (e.g., hotel reservations or car rentals), the merchant requests a pre-authorization from the customer’s bank or credit card issuer.
2. Temporary hold: The bank or card issuer places a temporary hold on a set amount of funds in the customer’s account. This hold makes sure the customer has enough available credit or funds to cover the transaction. However, the funds haven’t left the account at this point.
3. Authorization approval: The bank or card issuer checks the account’s available balance, and either approves or declines the hold. If it goes through, the merchant receives confirmation that the customer can pay for the transaction.
4. Finalizing the transaction: After the merchant delivers the goods or services or meets the transaction terms, the merchant adjusts the pre-authorization amount (if necessary) and processes the final payment.
5. Releasing the hold: If the transaction proceeds, the merchant completes the charge and releases the hold. If the merchant cancels or alerts the transaction, the merchant lifts the hold. That means they won’t charge the customer’s account.

What about pre-authorization charges that affect merchants? That’s right, business owners might also face pre-auth holds when they make purchases.

Pre-authorization charges can impact how you manage your purchases, especially if you're opening a new bank account, such as a business checking account to better handle your finances.

Understanding what you need to open a bank account—such as a government-issued ID, business license, and an initial deposit—can help ensure you're prepared. A business bank account not only simplifies business purchases (and, later, taxes) but also provides transparency in tracking pre-authorization holds and ensuring smooth transactions.

How Long Do Pre-Authorizations Last?

Pre-authorization holds typically last between 2 to 7 days. But, it just depends on the payment processor, the policies of the bank or card issuer, and the type of transaction.

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These timeframes can affect cash flow since the funds are tied up until the merchant finalizes the charges. For things like hotel stays or car rentals, the hold might last up to 30 days. If you don’t complete the charge within the hold period, the hold will automatically expire.

If you need more time, you might have to request an extension. During the hold, the customer won’t see the money taken from their account, but their available balance will be lower until the hold is gone or the charge goes through.

If you’re a small business owner, pre-authorization charges can be a double-edged sword. While they offer a layer of protection for merchants, they can also tie up your funds temporarily, which can be a cash flow challenge, especially if you’re using no annual fee business credit cards.

These cards offer a cost-effective way to manage your business expenses without the burden of annual fees, which is why they’re a popular choice for entrepreneurs. However, it's important to be aware of how pre-authorization charges can impact your available credit and plan accordingly.

When Would You Use a Pre-Authorization Charge?

Merchants use pre-authorization charges in industries like hospitality and travel, where they need to verify payment information before fulfilling a service.

For example, hotels also often charge pre-authorization fees to verify the validity of credit cards. With AI in hospitality, hotels can automate this process and reduce the risk of fraudulent transactions while also ensuring smooth check-ins and a positive guest experience.

Other situations or situations where you might need to confirm a customer’s ability to pay before providing goods or services include:

• Car rentals: Rental car companies use pre-authorizations to ensure customers have enough money for the rental and any potential charges like damages or gas. Example: Hertz uses pre-auth holds to protect its rental cars just in case a customer damages a car or fails to return it.

• Online purchases: In 2023, nearly half of global online sellers prioritized fraud and chargeback prevention and management. This is why when customers buy high-cost items online, many merchants will place a hold on the card to make sure the customer can pay before shipping the item.
• Gas stations: Gas stations may place a hold on a card for an estimated amount when a customer fills up their tank to ensure they have enough funds.
  Restaurants and bars: Some restaurants or bars place a hold on a card when customers order, especially if they expect tips or extra charges, to make sure the customer can cover the total cost.
• Events or travel ticket purchases: Merchants may use pre-authorization to check that customers have enough funds before finalizing tickets for concerts, flights, or events.
• Service-based businesses: Businesses that provide services, like spas or repair shops, may pre-authorize a card to confirm the customer can pay for the expected service.
• Subscriptions: For ongoing subscriptions, like gyms or streaming services, merchants use pre-authorization to make sure customers can pay for the service before they access it.

Benefits of Pre-Authorization Charges

As you’ve probably noticed, pre-auths can be a great asset to your cash flow and provide an added layer of protection for your business when customers make purchases.

Let’s look at some of those benefits more in-depth.

Security Against Failed Payments

Pre-authorization charges make sure your customers have enough funds to cover a transaction before you deliver any goods or services.

This minimizes the risk of chargebacks or failed payments, which can be costly and time-consuming to dispute. Chargeflow’s 2024 Chargeback Report found that disputes take up to 100 days to resolve (46 days on average). This puts a significant strain on both time and resources.

Fraud Prevention

Fraud is one of the most common reasons for chargebacks. Pre-authorization helps reduce the risk of fraudulent transactions by certifying the payment method is valid and has sufficient funds.

This brings peace of mind, especially if your business deals with high-ticket items or services that require upfront payment.

Improved Cash Flow Planning

By confirming the availability of funds before completing a sale, pre-authorization holds give you a clearer picture of your cash flow. This helps with budgeting and financial planning, especially if your business relies on customer deposits or advance payments.

Best Practices for Managing Pre-Authorization Charges

Be Transparent With Customers

Transparency helps you ensure a smooth transaction process. Always inform your customers about pre-authorization charges before they complete a transaction. Explain what a pre-auth is, why it’s necessary, and an estimate of how long the hold will last.

Include this information during the checkout process or your website’s FAQ section. In your email confirmations or receipts, highlight that the pre-authorization is temporary.

Choose the Right Payment Processor

Your payment processor will be handling your pre-authorizations. So, choose wisely. Make sure the processor can clearly track and manage pre-auth holds.

It should also offer features, such as real-time updates, transparency on hold periods, and automatic release once the transaction is complete or doesn’t go through.

Use a Chargeback Solution

Even with pre-authorization, chargebacks can still happen. A chargeback management solution can help streamline the process and allow you to dispute chargebacks with ease. These solutions often provide tools for tracking chargebacks, gathering necessary evidence, and automating responses.

Invest in a chargeback solution that integrates with your payment processor and offers analytics to help you understand trends in chargebacks.

Chargeflow’s integration with Stripe offers a best-in-class user experience natively in the Stripe dashboard.

Summary

Pre-authorization charges are a smart tool for eCommerce businesses looking to protect themselves from the growing risks of chargebacks and fraud.

You can safeguard your cash flow, reduce disputes, and enhance the overall customer experience. Pre-authorizations might require a bit more attention upfront, but the benefits win every time.