Payments

The Three Types of Payment Reversals

Payment Reversals

Table of Contents

  1. What Is a Payment Reversal?
  2. What Is an Authorization Reversal?
  3. What Is a Refund?
  4. What Is a Chargeback?
  5. How Do You Prevent Payment Reversals?
  6. Is a chargeback a reversal?
  7. How long do pending authorizations take?
  8. Can a cardholder cancel a pre-authorization?
  9. Can an EFT be reversed?

As much as they might prefer otherwise, every merchant had to deal with payment reversals now and then. Mistakes happen, and when a merchant fails to deliver what the customer paid for, it's their duty to provide a refund. In other cases, merchants may choose to reverse a payment after an error in processing, or simply to satisfy an unhappy customer. Of course, these kinds of payment reversals are voluntary, but there's another kind that isn't: chargebacks.

Each type of payment reversal has its own rules, restrictions, and costs. In order to make sure their businesses operate with maximum efficiency, merchants need to have a thorough understanding of their similarities and differences. Let's break down the different types of payment reversals, how each of them works, and how merchants can best use them to increase customer satisfaction and protect their bottom line.

What Is a Payment Reversal?

A payment reversal is any situation where a merchant reverses a transaction, returning the funds to the account of the cardholder who made the payment.

Payment reversals are not all created alike. Some have minimal impact on the merchant’s bottom line, and others can be quite costly. Different types of payment reversals can be initiated by the customer, the merchant, the card network, the issuing bank, or the acquiring bank. Not all payment reversals are bad, however.

When done early enough, a payment reversal can be minimally costly to the merchant while satisfying the customer and eliminating the chance of receiving a more expensive and damaging form of reversal later on.

There are three types of payment reversals:

  • Authorization reversals
  • Refunds
  • Chargebacks

Good policies, processes, and customer service can help you avoid all three types, but of course, the ones you really want to avoid are chargebacks. They’re the most costly by far, and they can harm your business in more ways than one.

By applying authorization reversals or refunds at the right time, you can avoid chargebacks and minimize the problems to your revenue and reputation that payment disputes can cause. But first, it’s important to understand how these reversals differ.

What Is an Authorization Reversal?

An authorization reversal is a type of payment reversal that can be performed immediately after a transaction, before settlement occurs and money has been withdrawn from the customer’s account.

New call-to-actionEssentially, it's an electronic communication to the issuing bank, sent through your payment processing system, which instructs them to reverse a transaction that was just authorized.

If a customer makes a purchase and changes their mind a short while later because they want to return the item or use a different payment method, you may be able to process an authorization reversal instead of a refund.

This is preferable because you won’t have to pay interchange fees the way you would if you processed a credit to refund a fully settled transaction. If you have the option to provide an authorization reversal, it’s always the cheapest, fastest, and best option for giving the customer their money back.

Authorization reversals can also increase customer satisfaction. Especially in the case of mistaken transactions, customers tend to be happier when the money never leaves their account than when a transaction is made and reversed.

Accounting is also made easier when an authorization reversal is used instead of another kind of payment reversal, since there's no gap between receipt of revenue and a reversal payment to the customer.

One of the most common situations in which merchants use authorization reversals is one in which the customer isn't involved at all. If a customer is accidentally charged the wrong amount or if a charge is processed more than once for the same purchase, an authorization reversal often serves as a quick and easy way to reverse the erroneous transaction. In many cases, the customer will never even  know about the mistake.

What Is a Refund?

A refund is a transaction wherein a merchant sends funds to a customer, often via a credit transaction. Refunds don't have any direct relationship to the original purchase other than the fact that they're often for the same amount.

If a transaction has already been settled, an authorization reversal is no longer an option. In situations like these, you can provide a refund, which is processed as a new and separate transaction that takes funds from the merchant account and credits it back to the customer’s payment card.

Refunds have to go through the same settlement and clearing process as other transactions, which means the customer doesn’t always get their money back instantly. The merchant is also obligated to pay interchange fees on every credit transaction, the same as they would if they were processing a regular charge.

Although a refund will usually take a few days to fully process, using a return authorization allows the customer to see the pending credit in their account almost immediately, reducing the chance that they'll get impatient and file a chargeback under the assumption that a promised refund isn't coming.

Because of their ability to prevent chargebacks, both Visa and Mastercard have mandated the use of these authorizations for all refunds.

However, when a customer is unhappy, a refund is often the best (and sometimes only) way to resolve the situation to their satisfaction. For this reason, it’s always a good idea to have a generous return and refund policy and to offer attentive and compassionate customer service when a customer comes to you with a problem. If you provide a refund and give them their money back, you can usually salvage the relationship with that customer.

The standard for return policies is always being redefined, and most merchants would do well to update their policies periodically to be at least as generous as average, if not more so. For example, it used to be standard practice in e-commerce for the customer to pay the return shipping on a product they want to return, but these days customers expect the merchant to pay for that as well.

Returnless refunds are also becoming more common, with the merchant refunding the customer without expecting the purchased product to be returned. While in some cases this is simply due to the cost of return shipping being higher than the value of the returned product, an increasing number of e-commerce merchants, especially those on Amazon, are offering this as a standard policy.

If you deny a customer a refund for any reason, there are two avenues that customer might take. Some might simply accept the denial and move on. However, it's increasingly likely that the customer will contact their bank and file a chargeback.

What Is a Chargeback?

A chargeback is a forced payment reversal initiated by the cardholder’s issuing bank, which takes money from the merchant and gives it back to the cardholder.

Under the Fair Credit Billing Act of 1974, all payment card issuers must offer a chargeback process to remedy fraud and abuse. If a customer brings a valid dispute claim to their bank, a chargeback will result.

Download the eGuide, 4 Reasons to Hire a Chargeback Management CompanyChargebacks are more costly than refunds—they carry additional fees that the merchant must pay. That’s not the worst thing about them, though. The real danger with chargebacks is that they can cause you to lose your merchant account.

The major card networks task their acquiring banks with monitoring chargeback rates and establishing thresholds for “excessive” chargeback activity. This is done to prevent fraudulent and reckless merchants from abusing the system and causing consumers to lose confidence in the safety of payment card transactions.

When merchants exceed acceptable chargeback thresholds, their acquirers and payment processors may terminate their accounts. There are “high risk” processors that will deal with merchants caught in that situation, but they can be very expensive and sometimes unreliable.

How Do You Prevent Payment Reversals?

Merchants can prevent payment reversals by submitting transactions promptly, avoiding processing errors, having a clear billing descriptor, and using effective fraud prevention tools.

One way to reduce payment reversals is to make sure your transactions are being submitted quickly. If you're waiting even a day or two to submit a transaction, the cardholder could be caught with insufficient funds after assuming the transaction already went through, or they could forget what the charge was for and file a chargeback.

Merchants can also avoid chargebacks by taking the opportunity to provide authorization reversals and refunds whenever required—but this only works when the customer notifies you of a problem.

Other chargebacks may occur because the customer doesn’t recognize a charge on their bank statement. Clear merchant descriptors, with your phone number and website URL included, can help to avoid this.

Some chargebacks are the result of fraud and can be prevented with AVS and CVV matching, and anti-fraud tools like 3-D Secure.

When customers make false claims and obtain chargebacks that do not have a legitimate basis, this is called friendly fraud.

With the right evidence that disproves these claims, merchants can fight these chargebacks and win back their revenue.

There are situations in which each of these different payment reversal types will be required, but merchants should do everything in their power to avoid chargebacks. Authorization reversals and refunds may cost you some revenue, but they can’t threaten your very ability to process payment card transactions the way chargebacks can.

Every merchant needs a strategy for preventing and fighting chargebacks and the fraud that can lead to them. A big part of that strategy is knowing when to offer voluntary payment reversals to keep customers happy and avoid disputes down the line.

FAQ

Is a chargeback a reversal?

Yes. A chargeback is a forced reversal, as opposed to a refund of a transaction.

How long do pending authorizations take?

A credit card authorization can last between 1-30 days, depending on when the merchant charges the account or lets the hold fall off.

Can a cardholder cancel a pre-authorization?

Yes. If a merchant refuses to cancel a pre-authorization, the customer can go to their bank to have the charge canceled.

Can an EFT be reversed?

Not without the consent of both parties involved. A reversal request can be filed for an EFT, but it will not be approved without the consent of the party who received the payment.


Thanks for following the Chargeback Gurus blog. Feel free to submit topic suggestions, questions or requests for advice to: win@chargebackgurus.com

Get the guide, Chargebacks 101: Understanding Chargebacks & Their Root Causes