Every penny counts in business, especially during the cost-of-living crisis where margins can be very tight. Sometimes the nature business can mean selling a high-ticket item, or service, or shipping a product over a long period of time. All of which can leave you out of pocket if the customer’s payment bounces after the product or service has been received.
This is where pre-authorised payments can really make a difference, but what is a pre-authorised payment? Do they work differently for credit cards and debit cards? In this guide, we’ll cover:
- What is a pre-authorised payment or charge?
- What is credit card pre-authorisation?
- What is a pre-authorisation on a debit card?
What is credit card pre-authorisation?
Let’s start with the main question, what does pre-authorisation mean? Pre-authorisation is a temporary hold placed on your customer’s payment card that’s used to verify that the account is both valid and contains sufficient funds to cover a pending transaction. However, the pre-authorisation doesn’t actually extract the money from the account.
What does it mean to pre-authorise a credit card?
In this case, it’s not about whether the funds are in a bank account but whether the card’s credit limit would cover the transaction.
Let’s use an example to better explain ‘what does pre-authorised credit card mean’:
- A customer has a credit limit of £1,500 and purchases an item worth £500 from you.
- Their limit now drops to £1,000, with a pending charge of £500 (the amount of the item they wish to purchase from your business).
- The customer now isn’t able to spend more than £1,000, ensuring that the £500 is available for the transaction when it completes.
During the pre-authorisation period the funds aren’t transferred to you, they’re held in a temporary reserve so that the customer can’t spend them on something else. This period usually lasts five days but can last up to 31 days and can relate to the total amount of the transaction or a partial amount.
The merchant category code determines how long this period lasts, which can allow you to release the hold as soon as the transaction is completed or continue to hold it for a longer period. This is normally the case only for specific transactions like rentals of properties (e.g. Airbnb) or vehicles.
If the transaction isn’t completed by the end of the pre-authorisation period, the funds will be reissued to the customer by the bank, which is known as a ‘falling off’. This ensures that they aren’t at risk of losing their funds if the transaction doesn’t get completed for any reason.
What does a pre-authorisation transaction mean for your business?
The benefits include avoiding chargebacks and card refund fees, which happen when a customer disputes the validity of the transaction. You can also guarantee that the customer is committed to paying for the service or product they’re receiving, reducing fraud and cutting costs on declined transactions.
Pre-authorisation is most commonly used in the hospitality industry, where it can be important to guarantee that funds are available in the case of additional charges, like the use of the minibar or in the event of damages being caused. The same logic applies to car rentals, holding onto the funds until the vehicle is returned to the correct standard and covering any additional expenses incurred.
For eCommerce businesses, pre-authorised transactions can be most useful when dealing with long shipping periods, ensuring that customers aren’t actually charged until they have received the item successfully (and intact), while still protecting you by holding onto their funds.
What is a pre-authorisation on a debit card?
We’ve covered how this works for credit cards, but what is a pre-authorisation on a debit card? Essentially, it works the same way as with a credit card, but the main difference is that the hold is placed on funds within the customer’s account.
Let’s work through the same example we used for credit cards but with a pre-authorised debit charge:
- A customer has £1,500 in their own debit account and makes a purchase of £500.
- This customer still has £1,500 showing as their total balance, however, their available balance drops to £1,000, with £500 being held as a pending purchase.
What does pre-authorisation debit mean for your business?
Again, it’s a way of protecting yourself from unnecessary chargebacks and fees and from unreliable customers who might try and buy, despite knowing they don’t have the funds.
It can also help you reduce the number of merchant discount rate fees that need to be paid for each authorised transaction as these wouldn’t need to be paid on pre-authorised transactions that aren’t completed.
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