A preauthorization charge is a temporary hold on a specific amount of the available balance on a credit or debit card. This charge checks that the card is valid and has sufficient funds to cover the transaction. The amount is set aside by the card issuer but not actually transferred to the business. This charge is typically used in situations where the final amount is not known at the time of the initial transaction, such as at hotels or gas stations.

The preauthorization ensures that the business can later charge the actual transaction amount. Once the final amount is assessed and charged, the preauthorization hold is released, and the actual amount is deducted from the account. If the purchase is not completed, the preauthorization amount is released back into the card’s available balance after a certain period, which can vary depending on the card issuer’s policies. This process is a standard practice to verify that a card is active and can cover potential charges. According to a report from the Federal Reserve Bank of San Francisco, 31% of all payments in 2022 were made with credit cards, emphasizing the importance for businesses to manage preauthorization charges diligently to ensure customer transactions are covered.

Below, we’ll discuss what businesses need to know about preauthorization holds. Although these charges may seem like a small detail, they come with large implications for the efficiency of the payment experience and the security of payments as a whole.

What’s in this article?

• How long does a preauthorization charge last?
  
• How do preauthorization charges work?
  
• Preauthorization charges and credit card transactions
  
• Advantages of using preauthorization charges
  
• What types of businesses typically use preauthorization charges?
  

How long does a preauthorization charge last?

A preauthorization charge on a credit or debit card typically lasts for about five to seven days, but this duration can vary depending on the card issuer’s policies and the type of transaction. Some banks may keep the hold for up to 14 days. In the case of certain businesses such as hotels or car rental companies, the hold might remain for an even longer period, potentially up to 30 days.

It’s important to know that if the actual transaction is processed before the hold period ends, the preauthorization hold is removed and replaced by the actual charge. If the transaction doesn’t go through, or if it’s less than the preauthorized amount, the hold is released. The unused funds then become available again in the cardholder’s account. This timeline for the release of funds can also depend on both the business’s and the card issuer’s processing times.

How do preauthorization charges work?

Preauthorization charges work as a method for businesses to verify that a card is active and has sufficient funds for a transaction, especially in cases where the total amount is not immediately known. Here’s how the process typically works:

• Initiating the preauthorization
  When you use your card for a transaction where the final amount isn’t known up front (such as at a gas station or hotel), the business will initiate a preauthorization. This is effectively a temporary hold of a certain amount on your card.

• Holding funds
  The preauthorization amount is not an actual charge but a temporary hold. This amount is deducted from your available balance, reserving these funds for the potential future transaction. The actual account balance doesn’t decrease at this stage. The length of time the preauthorization hold remains on your account can vary. It depends on the business’s policies and the card issuer’s practices. It usually ranges from a few days to a couple of weeks.

• Posting the final transaction amount
  Once the final amount of your purchase is known (for example, when you check out of a hotel), the business will complete the transaction. The preauthorization hold is then replaced by the actual charge of the final amount.

• Releasing unused funds
  If the actual transaction amount is less than the preauthorized amount, or if the transaction is canceled, the hold on the unused funds is released. This means the preauthorized amount (or the remaining part of it) becomes available again in your account.

Cardholders should monitor preauthorization holds because they temporarily lower the spending power of the card, which might affect future purchases. Businesses put these holds in place as a security step, especially when they’re delivering services or products before the final charge. It’s a way for businesses to safeguard against payment uncertainties.

Preauthorization charges and credit card transactions

Preauthorization charges on credit cards enable businesses to validate the card and ensure that the necessary funds are available. This process begins when a business sends a request to the cardholder’s issuing bank to verify the credit availability. The bank then places a hold on the card for the amount requested. This hold affects the credit limit but does not result in an immediate charge to the account, meaning no debt is incurred at the preauthorization stage.

Specific to credit cards, preauthorizations are a check against the cardholder’s credit limit rather than the balance in their bank account, as is the case with debit cards. This is an important distinction because it means preauthorizations reduce the amount the cardholder can subsequently spend, but they do not impact the actual funds in a bank account until the transaction is finalized.

Differences in processing preauthorizations across card types are primarily about where the funds are held from. When a preauthorization is applied to a debit card, the hold on funds affects the account balance and can potentially lead to situations where a cardholder could receive an “insufficient funds” warning on other transactions. Credit card preauthorizations, conversely, simply reduce the available credit.

When using credit cards, the preauthorization hold is lifted once the actual charge is processed and the real charge is then applied to the account—reflecting as a transaction that contributes to the cardholder’s debt. If the final charge is less than the preauthorized amount, the remaining hold is removed, thus restoring the temporary unavailable credit to the cardholder.

Different credit card issuers may have varied policies on how long a preauthorization hold can last before it drops off automatically. In the event a business does not finalize the transaction, the hold will eventually expire, but the time frame for this can range from a couple of days to a few weeks.

Businesses and card issuers communicate electronically for each transaction, and preauthorizations are part of this communication. They use a set of standardized codes and messages that allow for these holds to be placed and then either finalized into actual charges or released.

Managing preauthorizations—balancing payment security and customer experience—is a key aspect of transaction management for businesses. Understanding how preauthorizations work will help you optimize your payment processing and payment system for your business.

Advantages of using preauthorization charges

Preauthorizations provide a financial safety net for both businesses and customers. For businesses, they’re a way to make sure customers have the funds or credit they need before businesses commit to providing a service. This step is a guardrail against payment disputes and chargebacks, and it is especially handy in industries such as hospitality or car rentals where the full cost might not be known from the get-go. Locking in funds early helps you avoid surprises and makes sure that payments will land in your account as expected.

• Protection against surprise charges
  In sectors where the final bill might inflate—think hotels where guests might tap into the minibar, or car rentals with the potential for last-minute extensions—preauthorizations give businesses the ability to reserve an amount that covers potential costs. This certifies that businesses are compensated for the services they provide and also streamlines accounting and financial planning, allowing for more accurate forecasting and budgeting.

• Greater customer transparency
  Preauthorizations can also improve the customer experience by smoothing out billing hiccups. By guaranteeing funds up front, businesses can provide services with the confidence that they’ll be paid, allowing them to focus on delivering the best customer service without the looming concern of payment follow-ups.

• Customer benefits
  Preauthorizations can be advantageous for customers because they provide a way to assure service providers without making an immediate payment. It gives customers the flexibility to cancel without having been charged, in most cases, if the service is no longer needed. It also allows for a check on the account’s standing without the immediate financial impact of a complete transaction, helping to prevent overspending.

• Ease of operations
  Businesses can reduce the time spent on billing and payment collection through the use of preauthorizations, simplifying the transaction process by guaranteeing funds are available before providing services. These charges also provide a more organized way to manage reservations and bookings, as the hold on funds signifies a confirmed interest in the service.

• Simplified financial planning
  Financial management for both entities is also improved with preauthorizations. Businesses can forecast their receivables more accurately, while customers can monitor their spending and available credit or funds more closely. The process provides a layer of financial oversight that can contribute to better budgeting and financial planning.

What types of businesses typically use preauthorization charges?

Preauthorization charges are commonly used by businesses where the final amount of a transaction is not known at the start, or where there’s a gap between the initiation of a service and its completion. Here are some examples:

• Hotels and accommodations
  These establishments often use preauthorizations to cover potential incidental expenses or damages by securing an amount on a guest’s credit card.

• Car rental services
  Preauthorizations are used to hold an amount that covers the rental fee, insurance, and a security deposit for possible damages.

• Gas stations
  For pay-at-the-pump services, a preauthorization is used to verify that the card has enough funds to cover the fuel purchase.

• Restaurants
  Especially in situations where patrons open a tab, preauthorizations are used to confirm the payment method before the final bill is tallied.

• Retail stores with high-value items
  Some retailers may preauthorize a purchase amount to make sure that funds are available before processing expensive transactions.

• Online services and subscriptions
  Companies offering trial periods may preauthorize a small amount to verify the payment method, which will be charged if the subscription continues past the trial.

• Travel agencies and airlines
  When booking travel, preauthorizations are used to hold funds for ticket purchases and potential fees for changes or cancellations.

• Rental services
  This can include equipment rentals, furniture rentals, or any service where the final cost might depend on the return condition of the item rented.

Preauthorization can be adapted to various business models, particularly those that involve reservations, rentals, or services that are variable in nature.