How Does Credit Card Authorization Work?

Credit card authorization is a process that verifies a cardholder has sufficient funds or credit for a purchase. This real-time approval or denial allows merchants to know immediately whether to proceed with a sale. The process helps secure transactions, safeguarding against potential issues before goods or services are exchanged.

Key Players in Credit Card Authorization

Credit card authorization involves several entities, each playing a distinct role in facilitating the flow of funds.

The Cardholder is the individual who owns the credit or debit card and initiates a purchase. They present their card information to pay for goods or services.

The Merchant is the business that accepts credit card payments. They require a system to process these payments and ensure funds are transferred to their accounts.

The Acquiring Bank is a financial institution that processes credit or debit card payments for the merchant. It receives transaction details and routes them through card networks to the cardholder’s bank. Acquiring banks also maintain merchant accounts and facilitate the deposit of funds.

Card Networks, such as Visa and Mastercard, facilitate communication between acquiring and issuing banks. They establish transaction rules and operate the infrastructure that transmits data. These networks ensure transaction requests are routed correctly.

The Issuing Bank is the financial institution that issues the credit or debit card to the cardholder. It approves or declines transactions based on available funds or credit. The issuing bank also manages the cardholder’s account and handles fraud protection.

The Authorization Transaction Flow

The credit card authorization process begins when a customer initiates a payment, whether by physically presenting their card at a point-of-sale (POS) terminal or by entering card details for an online purchase. The merchant’s POS system or online payment gateway encrypts the cardholder’s information, including the card number, expiration date, and security code, along with the transaction amount. This encrypted data is then sent to the merchant’s acquiring bank.

Upon receiving the request, the acquiring bank routes the transaction through the appropriate card network, such as Visa or Mastercard. The card network then forwards the authorization request to the cardholder’s issuing bank. This step ensures that the request reaches the specific financial institution that manages the cardholder’s account.

The issuing bank receives the authorization request and performs several checks to determine whether to approve the transaction. It verifies the card’s validity, checks for sufficient funds or available credit in the cardholder’s account, and assesses the transaction for potential fraud or suspicious activity. This includes examining factors like the cardholder’s spending patterns, location, and the transaction amount.

After these checks, the issuing bank sends an authorization response back through the card network to the acquiring bank. The acquiring bank then relays this response to the merchant’s POS system or payment gateway. This entire communication process typically occurs within a few seconds.

An approved authorization places a temporary hold on the funds or credit line, ensuring they are reserved for that specific transaction, though the money is not yet transferred to the merchant.

For card-present transactions, authorization holds typically last one day, while card-not-present transactions may have holds lasting up to seven days. Some specific scenarios, like hotel or car rental pre-authorizations, can extend holds for up to 30 days.

Merchants may incur fees, such as authorization fees ranging from $0.02 to $0.15 per request, or misuse fees if authorizations are not settled within set timeframes.

Interpreting Authorization Outcomes

The final stage of the credit card authorization process culminates in either an approval or a decline, each carrying specific implications for the transaction. An “approved” status signifies that the issuing bank has verified the card’s validity, confirmed the availability of funds or credit, and found no immediate red flags for fraud. When a transaction is approved, an authorization code is generated, indicating that the merchant can proceed with the sale and expect to receive payment. This approval temporarily reduces the cardholder’s available balance or credit limit by the transaction amount, even though the actual transfer of funds, known as settlement, occurs later.

Conversely, a “declined” status means the transaction cannot be completed, and the issuing bank has rejected the authorization request. There are various common reasons for a decline, often communicated through specific decline codes. One frequent reason is insufficient funds or an exceeded credit limit, indicating the cardholder does not have enough money or available credit to cover the purchase. Another common cause is incorrect card details, such as an invalid card number, expiration date, or security code (CVV) entered during the transaction.

Declines can also occur due to suspected fraud, where the issuing bank detects unusual activity that deviates from the cardholder’s typical spending patterns or flags the card as lost or stolen. Technical issues, such as communication errors between systems or problems with the merchant’s equipment, can also lead to declines. Additionally, an expired card or a card that has not yet been activated will result in a declined transaction. Some declines, referred to as “soft declines,” might be temporary issues that can be resolved by retrying the transaction, while “hard declines” indicate more serious, often permanent, reasons for refusal.