Credit cards make paying for goods and services convenient for both the cardholder and the merchants. If the cardholder uses the credit prudently, he can make purchases during the month without having to use actual cash-on-hand; the money stays in his bank account and earns interest until it is time to pay the balance on the card. For retailers, a credit card can help secure payment, especially if the business requires preauthorizations.
Settlement
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A credit transaction involves three parties: the holder, the retailer and the credit card company. When the holder makes a purchase, the retailer submits the purchase to the holder's credit card company. A settlement is a term used to denote the completion of payment processing. When the credit card company deposits funds into the retailer's bank account, a settlement occurs.
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Preauthorization
A preauthorization is a temporary hold placed on a credit or debit card. It is not an actual charge, although it does temporarily make the hold amount unavailable until the settlement or transaction clears. Companies use preauthorizations to help secure payment. For example, motels often place holds on cards to prevent the cardholder from avoiding making the payment by maxing out the card .
Common Uses
Preauthorizations apply to several transactions. In general, gas stations, hotels, transportation services and restaurants routinely use preauthorizations. With regard to transportation services and restaurants, the preauthorization may be higher than the actual transaction price since the companies may tack on a percentage of the total to cover gratuity.
Example
John needs to get to the airport, so he hires a taxi service and pays with his credit card. The total price for the trip is $75. The taxi company places a preauthorization hold on his card of $86.25 – that cost covers the trip price plus 15% for gratuity. John pays a cash tip on arrival. Once the charge is posted, the preauthorization is removed. Removing the preauthorization may take time; the time depends on John's credit card company. Settlement occurs when the credit card company transfers the $75 into the taxi driver's account.