Pre authorization

Pre authorization, often referred to as a "pre-auth" or "authorization hold," is a temporary hold placed on a customer's available funds by a merchant or service provider. This financial transaction mechanism is a crucial part of Payment Processing within the broader category of Financial Transactions, designed to ensure that sufficient funds exist to cover an impending charge. It does not deduct the funds immediately but reserves them, reducing the customer's available balance or credit limit by the specified amount.

What Is Pre authorization?

Pre authorization is a temporary blocking of funds on a credit card or debit card account to ensure that the cardholder has enough money or credit available to cover a future transaction. It's a common practice across various industries, serving as a form of Risk Management for businesses by mitigating the risk of non-payment. This process involves the merchant sending a request to the cardholder's bank (the issuing bank) to verify Funds Availability for a specific amount. If approved, the bank places a temporary "hold" on those funds, which are then unavailable for other transactions until the final charge is processed or the hold expires.

History and Origin

The concept of pre authorization evolved alongside the widespread adoption of credit and debit cards, becoming an integral part of modern electronic payment systems ⁸. As merchants sought ways to minimize losses from insufficient funds or declined transactions, especially in scenarios where the final transaction amount was unknown at the outset (e.g., gas stations, hotels, rental cars), pre authorization emerged as a practical solution. Early electronic payment systems required some form of real-time verification, and authorization holds provided this assurance without immediately finalizing the transaction. The evolution of financial institutions and payment networks has seen these protocols standardized to protect both merchants and consumers, addressing concerns such as Fraud Prevention and efficient transaction flows. The Federal Reserve, for instance, has policies on payment system risk to foster safety and efficiency in financial market infrastructures, underscoring the importance of such mechanisms in the broader financial system.⁶, ⁷

Key Takeaways

Pre authorization temporarily reserves funds on a customer's card without immediately charging them.
It ensures funds are available for an upcoming transaction, reducing financial risk for merchants.
Commonly used in industries like hospitality, automotive rentals, and fuel sales where the final charge is uncertain.
The hold amount can sometimes exceed the final transaction amount, potentially impacting a cardholder's available credit or balance.
Pre authorizations typically expire within a few days, at which point unused funds are released.

Interpreting the Pre authorization

Understanding pre authorization involves recognizing its purpose and implications for both the consumer and the merchant. For consumers, a pre authorization means a portion of their available credit limit or bank balance is temporarily inaccessible. This can be particularly relevant if a consumer is close to their limit or has limited funds availability. The exact amount of the hold can vary; for example, gas stations might place a higher hold than the anticipated fuel purchase to account for a full tank, or hotels might authorize for the room rate plus an estimated amount for incidentals.

For merchants, a pre authorization provides an authorization code from the card issuer, confirming that the transaction amount is approved and the funds are reserved. This minimizes the risk of a chargeback due to insufficient funds and ensures payment for services rendered, even if the final amount differs slightly from the initial estimate. The merchant then processes the final transaction, which settles the actual amount, releasing any excess held funds.

Hypothetical Example

Imagine a customer, Sarah, rents a car for a weekend trip. The rental car company typically requires a pre authorization to cover potential damages, additional mileage charges, or fuel costs.

Initial Pre authorization: When Sarah picks up the car, the rental company swipes her credit card and places a $300 pre authorization. This amount is not charged to her account but is temporarily held, reducing her available credit by $300.
During Rental: Sarah uses the car, drives the expected mileage, and returns it with a full tank.
Final Charge: When she returns the car, the actual rental cost is $150. The rental company then processes a final charge for $150.
Release of Hold: The bank releases the remaining $150 of the pre authorization, making it available again to Sarah. This process can take a few business days, depending on the bank's policies.

This example illustrates how pre authorization ensures the merchant is protected for potential costs while only charging the actual amount incurred.

Practical Applications

Pre authorization is a ubiquitous tool across several industries, essential for managing risk in modern financial transactions.

Hotels: When checking into a hotel, a pre authorization is typically placed for the estimated stay plus an amount for incidental expenses like mini-bar purchases or room service. This protects the hotel from non-payment.
Car Rentals: Similar to hotels, rental car companies use pre authorizations to cover the rental cost, fuel, and potential damage waivers.
Gas Stations: When paying at the pump with a debit card or credit card, a temporary hold for a higher amount (e.g., $75-$175) may be placed to ensure the card can cover a full tank, even if the customer only pumps a few gallons.⁵ The Federal Trade Commission (FTC) provides guidance to consumers on how these holds work.³, ⁴
Online Services & Subscriptions: Some online services may use a small pre authorization (e.g., $1) to verify card validity before setting up a recurring subscription.
Medical Services: In some healthcare scenarios, particularly for elective procedures or large expenses, a provider might obtain a pre authorization from an insurance company, ensuring coverage before services are rendered.
Security Deposits: For items like equipment rentals, a pre authorization can function similarly to a Security Deposit, ensuring funds are available in case of loss or damage, without immediately transferring money. A New York Times article highlights the inconvenience some consumers experience due to these holds.²

Limitations and Criticisms

Despite its utility, pre authorization has certain limitations and can lead to consumer frustration.

Unavailable Funds: The primary criticism is that the held funds reduce the customer's available balance or credit limit, even if the final charge is less. This can lead to unexpected declines for subsequent purchases, especially for consumers with tighter budgets or lower credit limits. A general "hold" on funds can effectively tie up a portion of a consumer's financial capacity.¹
Delayed Release: While pre authorizations are temporary, the time it takes for the hold to be released after the final transaction or cancellation can vary. It might take several business days for the funds to become available again, depending on the bank's processing times, which can be inconvenient for consumers.
Discrepancy in Amounts: The pre-authorized amount can sometimes significantly exceed the actual final cost, as seen in fuel purchases or hotel stays, which can be particularly problematic for debit card users who are dealing with their direct bank balance.
Lack of Transparency: Consumers may not always be fully aware of a pre authorization or its exact amount, leading to confusion when they see their available funds reduced. Consumer Protection efforts aim to increase transparency around these practices.

Pre authorization vs. Pre-Approval

While often used interchangeably in casual conversation, "pre authorization" and "pre-approval" refer to distinct concepts in financial contexts.

Pre authorization is a temporary hold on funds, specifically for a transaction that is about to occur or has just occurred, where the final amount is yet to be settled. It's a real-time verification of funds availability at the point of sale or service. It creates a temporary hold on existing funds.

Pre-approval, on the other hand, typically refers to an initial assessment by a lender (like a bank or merchant account provider) of a borrower's creditworthiness for a loan or line of credit. It indicates that, based on a preliminary review of financial information, an individual is likely to qualify for a certain amount of credit or a loan. Pre-approval does not guarantee final approval and does not involve holding funds. It's often used in lending, such as for mortgages or credit cards, to give consumers an idea of what they might qualify for before a full application and underwriting process. It concerns potential future credit, not a hold on current funds.

FAQs

How long does a pre authorization hold last?

The duration of a pre authorization hold varies but typically ranges from a few days to up to 10 business days. Factors influencing the hold duration include the merchant's industry (e.g., hotels often have longer holds than gas stations), the specific card network rules, and the cardholder's issuing bank's policies regarding the release of funds.

Can a pre authorization be declined?

Yes, a pre authorization can be declined if there are insufficient funds availability on a debit card or if the transaction would exceed the credit limit on a credit card. It can also be declined due to security reasons, such as suspected fraud prevention measures.

Is a pre authorization the same as a charge?

No, a pre authorization is not the same as a charge. A pre authorization is a temporary hold on funds that verifies their availability, while a charge (or settlement) is the final transaction that actually transfers the funds from the customer's account to the merchant's account. The pre authorization effectively reserves the funds for the eventual charge, ensuring the merchant gets paid.

What happens if I cancel a service after a pre authorization?

If you cancel a service after a pre authorization has been placed, the merchant should release the hold. However, the time it takes for the funds to become available again can vary. It may take several business days for your bank to process the release and update your available balance or credit limit. You may need to contact the merchant or your bank if the hold persists beyond a reasonable timeframe.

Can a pre authorization convert to a different amount?

Yes, a pre authorization can convert to a different amount, typically a lower one. For instance, when a gas station places a higher pre authorization but you only pump a small amount of fuel, the final charge will reflect the actual, lower amount. The excess pre-authorized funds are then released. This is common in scenarios where the final cost is not known at the time of the initial authorization.