Authorization Hold in Payment Processing Explained

Introduction

It is in every merchant’s interest to ensure payment for their products or services, prevent chargebacks, and protect themselves and their customers from fraud. One payment processing tool that does all of this, and more, is called an authorization hold.

Find out what authorization holds are, how they work in practice, and why some merchants consider it an invaluable tool for their business.

What Is an Authorization Hold?

An authorization hold (also known as a pre-authorization or a credit or debit card authorization) is a temporary hold placed on a portion of available credit on a cardholder’s account.

Businesses initiate authorization holds in two cases:

1. When the final transaction amount is still to be determined.
2. When delaying the settlement provides a certain benefit to the business, like allowing time for payment fraud checks.

Authorization Hold Example

If a cardholder has a $2000 card limit on their credit card, and get a $300 hold placed on it, the remaining usable balance is reduced to $1700.

Suppose a person rents a car. They will get an authorization hold placed on their card equaling the anticipated cost of the service, and (sometimes) additional fees, for example, for damage coverage, excessive fuel usage, or extra benefits (navigation device, entertainment subscriptions, etc.).

How Do Authorization Holds Work?

To set an authorization hold, a business must initiate an authorization only transaction. The transaction is followed by a balance check. After that, the business’s bank sends one of the following replies:

• Approved – The card used is satisfactory, meaning there are sufficient funds in the account and no reports that the card was lost or stolen.
• Partially approved – The card was not reported lost or stolen, but the account might have insufficient funds.
• Declined – The card is unacceptable, whether due to insufficient funds or the card being reported lost or stolen.
• Referral – There is an issue with the card number and the customer must contact the issuing bank to resolve it.
• Incorrect PIN – The transaction cannot complete because the cardholder entered an incorrect PIN.
• Card expiration – The card has expired, or the customer entered the wrong expiration date. The customer must correct the expiration date or use a different card.
• Pick up card – This message instructs the merchant to retain the card for one of the following reasons: fraud attempt, card loss or theft, or closed account.

To claim a portion or entirety of the reserved funds, a business must process a prior authorization capture transaction. If only a portion of the reserved funds is claimed, the cardholder regains access to the rest of the funds.

A merchant can at any moment remove an authorization hold at their discretion. This typically happens when a customer cancels their order, or if, after manual review, there is reason to believe that a transaction was made with malicious intent.

Customers can request to remove an authorization hold by contacting their bank and sending a stop payment request. If the bank deems the request valid, it will contact the merchant and request the hold be removed.

What Happens When an Authorization Hold Expires?

If a merchant does not finalize the transaction, and neither they nor the cardholder remove the hold, the hold expires. As a result, the cardholder regains access to the previously reserved funds.

When that happens, the business must resubmit the transaction for processing, which often incurs a misuse fee. This is a penalty card networks impose for not settling or removing a transaction within the given time limit.

Why Do You Need Authorization Holds?

Authorization holds are a versatile payment processing tool because they allow a business to:

• Determine whether a customer has sufficient funds for a transaction before initiating it.
• Reserve funds when a transaction’s final amount is unknown at the time of initiation.
• Inform cardholders about an incoming transaction (e.g., after their order has been shipped).
• Prevent chargebacks by allowing both participating parties to cancel a hold before the transaction is settled.
• Prevent fraud attempts by reserving funds while performing a fraud check.

How Long Do Authorization Holds Last?

The exact duration of an authorization hold depends on the following factors:

• Card network regulations – Card networks establish all the rules related to authorizations, including who can make them, how long they last, and what amount can be reserved.
• Type of card – Typically, debit cards have a hold of 1-8 business days, while credit cards can have a hold of up to a month.
• Bank policies – Banks can shorten existing deadlines if they feel they need to.
• Card presence – Card-present transactions settle the same day, while card-not-present transactions can take up to a month, depending on the other factors involved.
• Payment type – Authorization holds for one-time transactions typically last up to a week. However, authorization holds can last as short as one day for recurring payments. The customer’s payment information was checked when the subscription was initiated, so unless the information changed, the customer is deemed trustworthy.
• Merchant category code (MCC) – A merchant’s category code affects how long an authorization hold lasts and the amount that can be reserved.

The following table lists typical authorization hold durations granted to different merchant categories:

Can Authorization Holds Prevent Chargebacks?

An authorization hold delays payment processing, protecting the merchant from chargebacks and fraud. This is because authorization holds:

• Are not subject to chargebacks – A customer can dispute an authorization hold, but they cannot initiate a chargeback. This is important for merchants as chargebacks are costly, time-consuming, and negatively impact their standing with banks, payment processors, and card companies.
• Allow time for fraud checks – Initiating an authorization hold gives merchants time to review suspicious transactions and implement fraud prevention measures.
• Make refunds easier – If a customer cancels their order before the transaction is settled, refunding them is as easy as canceling the authorization hold. The easier customers can obtain a refund, the less likely they are to initiate a chargeback request.

Note: The terms dispute and chargeback are sometimes used interchangeably, creating confusion. For an explanation of the differences between these two processes, refer to our article Chargebacks vs. Disputes: Definitions and Differences.

What Can Go Wrong With an Authorization Hold?

Without the right processes in place, authorization holds can do more harm than good.

Some of the issues associated with authorization holds include:

• Expiration – Regulations regarding time limits are often vague or conflicting. This results in expired holds. Merchants must do everything in their power to familiarize themselves with the rules regarding holds and establish processes to avoid authorization hold expiration. One way to do this is to consult their acquiring bank or payment processor.
• Administrative mistakes – Authorization holds require flawless recordkeeping. Administrative errors can lead to fees, delays, penalties, and a damaged reputation.
• Multiple holds – Merchants can place multiple authorization holds on the same transaction. A common example is when merchants fail to reverse a hold for a canceled transaction. It is crucial to avoid errors like this because customers unfairly lose access to a portion of their funds.

Before implementing authorization holds, merchants must avoid the abovementioned pitfalls to prevent errors, ensure customer satisfaction, protect their reputation, and preclude unnecessary penalties with card networks.

Authorization Hold Benefits and Drawbacks

Here is a summary of the benefits and drawbacks of authorization holds.

Conclusion

You now know what authorization holds are, how they work, and how merchants use them to their advantage.

Examine the information in this guide to determine whether using authorization holds would benefit your business, and how to avoid common mistakes.