What Is an Authorization Hold and What Is It For?
Authorization holds are a useful tool in the credit card processing toolbox to ensure sufficient funds are available when you’re ready to process them. For some industries, authorization holds are standard procedure. The hold is placed on a cardholder’s account, and their bank reserves the transaction amount. Cardholders can’t spend the amount of the hold, but merchants also haven’t yet taken it.
Below we explore in more detail what an authorization hold is, what it’s used for, and how you can use it to prevent fraud.
What Is an Authorization Hold?
When a customer puts their debit or credit card down for a transaction, an authorization hold puts a temporary hold on the funds in the customer’s account but doesn’t actually process the transaction. So, say your customer has a $3000 credit card limit, and the authorization hold is for $300. They would only have access to $2700 of their credit limit.
Authorization holds go by a few names in the industry, including purchase authorization or temporary authorization. There are a few reasons merchants would want to use this:
To ensure the customer has enough funds
If you’re selling tickets to an event, for example, you want to ensure the customer has the funds to cover the purchase before you go ahead and sell them the ticket.
To protect against fraud
By holding onto the funds until the transaction is complete, you can help prevent fraudsters from using stolen card information to make a purchase and then disappearing before you can process the transaction.
To hold a reservation
If you’re a hotel or rental car company, you may want to place an authorization hold on a customer’s card to ensure they have the funds to cover their stay or rental.
Holds ensure that the customer has the necessary available funds for the purchase. Merchants guarantee they’ll receive payment for their goods or services. And if the customer tries to cancel the transaction or dispute it later, there is an available balance to complete a reversal. Assuming it is appropriate based on the business’s cancelation/returns policy.
- An authorization hold is a tool used by merchants to ensure that customers have an available balance to cover their purchases.
- It’s a way to protect against fraud and hold reservations.
- Merchants can guarantee they’ll receive payment for their goods or services, and if the customer later tries to cancel or dispute the transaction, the funds will still be available.
- Authorization holds are standard procedure in industries, such as hotels and rental cars, but can be applied to many more.
How Do Authorization Holds Work?
With every transaction process, there are a lot of moving pieces that go on behind the scenes. In many cases, these are automatic. Your payment processor is doing all of this in the background. But it’s still worth understanding the steps to work out where the authorization hold fits in.
The first step is, of course, the customer initiates the purchase with their card. This can be done in person or online.
Then, the merchant contacts their acquirer (a.k.a. the bank that handles their payment processing) and submits what’s called an authorization request. This request includes the customer’s account information, the authorized amount, and sometimes additional information like the customer’s zip code.
Please note “contacting the acquirer” does not mean that merchants have to physically pick up the phone and contact their acquirer every time they want to process a transaction. In many cases, the authorization request is submitted automatically when the card is swiped or inserted into the point-of-sale (POS) system.
The acquirer then forwards the request to what’s called the issuing bank (e.g., the cardholder’s bank). They’re responsible for making sure the request is valid and that the customer actually has available credit to cover the purchase.
If everything checks out, the card association approves the transaction and sends an approval code (a.k.a. merchant category code) back to the acquirer. The acquirer then notifies the merchant that they can go ahead and complete the transaction.
At this point, the funds are not actually transferred from the customer’s account to the merchant’s account. Instead, the card association places a hold on those funds. The customer’s bank may also place a hold on those funds (but not always). This is what’s known as an authorization hold.
Once the merchant has provided the goods or services, they request that the transaction be settled, which means that the funds are transferred from the customer’s account to the merchant’s account—the final transaction. The acquirer sends a batch of these transactions to the issuer at the end of each day, and the issuer transfers the funds to the acquirer. The acquirer then deposits them into the merchant’s account.
Who Should Use Authorization Holds?
Hotels, car rental companies, and other rental services are the industries using the authorization hold mechanism the most. They are standard in these sectors as the moment of booking and the moment of processing the payment are usually quite far apart. They are also industries where customers may want extras or need a deposit.
For example, at a hotel, the customer may order room service or other hotel services. There would be a hold on their account to cover these costs, which would be released when they check out, less the total amount of their tab.
Car rental companies, similarly, will often hold a deposit amount to cover insurance costs in case there is damage to the vehicle.
Many other MCCs (merchant category codes) outside of hotels and rentals can use auth holds.
Online service providers with monthly membership fees, like cloud storage companies or gyms, commonly use authorization holds. In this case, the hold is placed at the beginning of each month and released after the service has been provided.
Some utility companies also use it to make sure that customers have the funds available to pay their bills. They place a hold for the estimated amount of the bill a few days before it’s due and release it once it has been paid.
Recurring payments provide another example. Say a customer signs up for a subscription service that ships a new box of goods to them each month. In this scenario, the merchant would place an authorization hold for the estimated amount of each shipment a few days before it ships and release the hold after the customer has received their goods.
Even gas stations use card authorization holds. Many have policies to put a hold on a certain amount before the customer first pumps gas. This is then released, less the actual charges for the transaction, once the customer has paid.
Benefits of an Authorization Hold
There are several benefits of using authorization holds:
- It’s a way to ensure that customers have the funds available to pay for a purchase, reducing the risk of declines.
- It gives merchants more flexibility on when they actually process payments. For example, a hotel can place an authorization hold at the time of booking, even if the customer doesn’t check in for several days.
- It allows merchants to batch transactions together and process them all at once, which can save on transaction fees.
Drawbacks of an Authorization Hold
There are also some potential downsides to using authorization holds:
- If a customer doesn’t have enough funds available in their account, the transaction will be declined. This could result in a lost sale.
- If a customer has a small account balance, an authorization hold could cause an overdraft on their account and incur fees.
- If a customer cancels their purchase after an authorization hold has been placed, it can take a few days for the hold to be released. In the meantime, they may not have access to those funds.
How to Use Authorization Holds
If you’re a merchant who wants to use authorization holds, there are a few things you need to do.
First, you need to ensure that your POS system can submit an authorization request and store the approval code. You also need to make sure that your POS system is able to send the request for settlement. This can all be managed through your credit card payment processor.
Second, you need to let your customers know that you’ll be placing a hold on their accounts. You should do this at the time of purchase, either in person or on your website.
Third, you need to decide how long you want the hold to last. This will depend on your business and your particular needs.
Finally, you need to make sure that you have the customer’s account information handy when you’re ready to request settlement. This includes the account number, expiration date, and security code.
Your payment processing company is the intermediary with the technology to set up and process your authorization holds. You simply need to contact them to set it up for your account. If you are signing up with a new payment processing company, you will need to provide them with:
- Your business name, address, and contact information
- Your bank account information
- Your tax ID number.
Once your POS is set up to process authorization holds, you’re good to go.
When exploring payment processing providers, make sure you also look at how they can save you money on your credit card processing fees. At Payment Depot, we do this by offering membership-style payment processing, giving you access to interchange rates with no markup, no hidden costs, and no cancelation costs.
Contact Payment Depot today to access low-fee payment processing with high POS functionalities, such as authorization holds.
Do authorization holds apply to debit cards as well as credit cards?
Sort of, yes. Authorization holds can be placed on both credit and debit card transactions. However, using a debit card as the payment method will mean the funds will be deducted from the customer’s bank account immediately. The process is the same, but it’s more like a standard transaction as the money moves straight from their account to the merchants.
How long does an authorization hold last?
The length of time an authorization hold lasts will depend on the merchant. Some merchants may only place a hold for a few hours, while others may hold the funds for several business days.
How long can you keep a credit card authorization on file?
There is no set time limit for how long a credit card authorization can be kept on file. However, it’s generally recommended that authorizations only be kept on file for as long as necessary. Once a purchase has been made, the authorization should be processed, and the funds should be transferred from the customer’s account.
What is an authorization code?
An authorization code is a six-digit code that the card issuer generates to approve an individual transaction. This code is unique to each transaction and helps ensure that the cardholder authorized the purchase.
Do authorization holds help prevent chargebacks?
Unfortunately, authorization holds are not a guarantee that you won’t get charged back. They may help to reduce the risk of friendly fraud chargebacks (i.e., when a customer falsely claims that they never received the goods or services). But, they do nothing to help prevent chargebacks of other types, like merchant errors or criminal fraud. Still, with friendly fraud on the rise, according to a recent study, reducing these types of chargebacks can have a big, positive impact on your bottom line.
To further reduce the risk of friendly fraud, we recommend sending your customer an email confirmation as soon as you place the authorization hold. This will serve as documentation that they agreed to the purchase and were aware that the funds would be temporarily unavailable.
What’s the difference between an authorization hold and a pre-authorization?
An authorization hold is placed on a customer’s account to temporarily reserve funds for a purchase that has not yet been made. On the other hand, a pre-authorization hold is used to verify that a customer’s card is valid and has the available funds to cover a purchase. Once the pre-authorization is complete, the funds are immediately transferred from the customer’s account. The authorization hold can, conversely, be held for a period of time before the funds are transferred.