A Visual Breakdown of Fund Holds
Below is an animated presentation providing an overview of the reasons credit card processors and merchant account providers place holds on merchant funds. Please feel free to leave your questions and comments on the comment section below.
Why Credit Card Processors Place Holds on Merchant Funds
(Click the arrows on the bottom to move through the presentation)
In case you are unable to see the presentation, or if you prefer reading, here is a summary:
Credit card processors place holds on funds primarily due to risk. This risk comes in three main forms: merchants closing accounts while still owing fees, chargebacks, and fraud. But how do these things cause risk for processors?
Processors Can Get Hung Out to Dry
The answer is simple, really: merchant accounts are not depository accounts like checking and savings accounts. Rather, they are considered a “line of credit.” Think of it like this: When a customer pays with a credit card, a bank is extending credit to that customer and making the payment on his/her behalf. Additionally, processors pay merchants before the banks collect from customers and are therefore extending credit to the merchant. Essentially, credit card processing companies act as middlemen between banks and merchants and accept responsibility for issuing debits and credits between the two. As middlemen, they can be left holding the bill if a bank is owed money but they are unable to collect from the merchant.
A Common Chargeback Scenario
For example, imagine that a merchant charges a customer for a large purchase (either legitimately or fraudulently). Shortly after the transaction the merchant goes out of business, or if a fraudulent company, disappears to never be seen again. Later, the customer disputes the charge, thereby initiating a Chargeback (in many cases, customers have up to 180 days to dispute a credit card charge.). Since the merchant no longer exists, the processor must pay the bank using its own money because it can’t collect from the merchant. In fact, Chargeback scenarios are one of the most common ways that processors suffer losses; however, merchant fraud is also a great concern.
Fund Holds Protect Processors From The Worst-Case Outcome
In summary, credit card processors place holds on merchant funds in order to shield themselves from the risk of chargebacks, to avoid suffering losses due to merchants conducting fraudulent transactions, and to ensure that they can pay fees that may not be recoverable due to a business closing. Other significant risk factors for a processor include an inability to deposit or withdraw fees from a merchant’s checking account, potential losses posed by high-risk business types, and transactions where the probability for Chargebacks or fraud is higher than normal.
[Related: “High Risk” Merchant Accounts Explained]
Keep in mind that each processor may have its own policies regarding what types of transactions it will hold and when/how long it will place holds. Some processors handle these situations well and others do not. If you feel that you are at a higher risk of experiencing holds, be sure to present your concerns with the processor prior to setting up an account.