What is a payment reversal? The different types and how to prevent them

If you’re a small business owner, experiencing a payment reversal can be frustrating. However, the majority of payment reversals are perfectly legal and covered by consumer rights laws, meaning you need to be prepared for them and budget accordingly.

In this article, we’ll take a look at exactly what payment reversals are and how you can aim to avoid them.

What is a payment reversal?

A payment reversal is an umbrella term that refers to the process of returning funds to a cardholder’s bank after they have made a payment.

A payment reversal can be initiated by the customer, the merchant, or the bank, and can occur for a variety of reasons.

A payment reversal effectively undoes a transaction and typically occurs with digital and card transactions.

The main types of payment reversals

There is more than one type of payment reversal. Let’s take a look at what they are and how they may impact your small business.

Chargebacks

From a merchant’s perspective, a chargeback is the least desirable type of payment reversal.

Chargebacks are usually initiated by the customer, who will contact their bank and dispute the transaction to receive their money back.

A customer may request a chargeback for a variety of reasons, including:

• The item they ordered does not arrive/gets lost in the post
• They do not recognise the transaction/they did not make the purchase
• There is a disagreement as to whether they qualify for a refund.
• They are committing fraud

As the merchant, you will not only have to repay the money, but in cases where a physical product was bought, you’ll also have to cover shipping fees to have the item returned to you (with no guarantee that you will receive the item back).

You’ll also have to pay a chargeback fee, and if you incur too many chargebacks, you may be flagged up by card networks. Major card schemes such as Mastercard and Visa monitor merchants’ chargeback rates and issue penalties and fees if they deem them too high.

While many chargeback claims are made in good faith, some can be the result of a fraud attempt. As a small business, you have to be prepared for the fact that you may never be able to prove if some chargebacks are legitimate.

Chargebacks are time-consuming and expensive for merchants, and while you can challenge them, the process is complicated and outcomes are often not in a merchant’s favour.

Refunds

A refund is one of the most common types of payment reversal and one that you are likely already familiar with as a small business owner.

A refund takes place after a transaction has been completed. It’s a brand new transaction, completing the original transaction in reverse.

Refunds usually take place when a customer is unsatisfied with the item they purchased, and are a result of direct communication between the customer and the merchant.

Under UK law, in most cases, a merchant must provide a full refund if a customer wants to return an item. A customer usually has 14 days to tell you they want a return (for example, by requesting a return on your online portal) and another 14 days to return the item(s) to you.

Customers are not legally entitled to a refund if:

• They simply changed their mind about the item (although many merchants will offer a refund in this circumstance).
• They have damaged the item.
• They knew the item was faulty when they bought it.

Refunds usually undergo a settlement process, meaning they can take a few days to process and appear on both the merchant and the customer’s bank statements.

As the merchant, you’ll also face interchange fees on the credit transaction. Make sure you have a clear and legally binding refund policy written up and displayed clearly on your website and in-store.

Authorisation/pre-authorisation reversal

An authorisation reversal is the process of reversing a transaction before it has been fully completed.

When a customer makes a payment using their credit or debit card, the transaction will be pre-authorised by their bank. This pre-authorisation confirms to the card processor and the merchant that the required funds are available in the customer’s bank.

If either end of the transaction, the merchant or the customer, notices an error with the transaction, they can contact the acquiring bank and stop the transaction before it has been completed.

This type of payment reversal stops money from actually being exchanged and is the preferable type of payment reversal for merchants. This is because it usually doesn’t involve fees, includes fewer parties, and doesn’t impact sales data.

Pre-authorisation reversals are usually pretty speedy too, meaning money will be returned to the customer quickly, creating a better experience for everyone involved.

If you receive direct debits from customers – for example, if you offer a subscription service that customers pay for monthly – you may also encounter returned direct debits. This is where the direct debit “bounces” and is not completed, usually due to insufficient funds in the customer’s account.

Keep a close eye on these, as you don’t want to be distributing your goods or services to customers who aren’t actually making the payment.

Fraud

Unfortunately, there is another type of payment reversal: fraudulent ones.

There are two types of fraudulent payment reversals to be aware of. The first is when a customer is a genuine victim of fraud and a fraudster has used their bank details to make a purchase from your small business.

A customer can request a chargeback for the amount, but you will be none the wiser about who the fraudster is and where your items are.

The second type of fraudulent payment reversal is when a customer requests a reversal, usually chargeback, for illegitimate reasons. For example, they claim the item has not arrived when it has.

Reasons for payment reversals

As a small business owner, you will need to be prepared for payment reversals and budget for them accordingly.

There are various reasons why legitimate payment reversals occur, such as:

• The customer is requesting a legitimate refund after purchasing the item(s) in good faith
• The item went out of stock before it could be dispatched and delivered to the customer
• The merchant requested the wrong amount from the customer’s bank
• The transaction was duplicated and the customer paid twice
• The transaction was fraudulent

The cost of payment reversals

Payment reversals can be costly for businesses thanks to the fees that come with them.

Some of the consequences and fees you may face as a result of a payment reversal include:

• Penalty fees – chargebacks come with a high cost for merchants. Mastercard predicts that each chargeback costs merchants between $15 and $75.
• Transaction costs – even though you reverse the payment, you’ll still have to pay the processing and transaction fees to your payment processor. If you issue a refund, as it’s technically two transactions, you may end up paying processing fees twice.
• Reputation costs – multiple payment reversals can not only lead to penalties and fees, but card networks may decide you’re an untrustworthy merchant and ban you from their network. Similarly, if customers have to make multiple or frequent reversal requests to you, they won’t keep shopping with you in the future, damaging your bottom line.

Ways to prevent payment reversals

While you may not be able to prevent payment reversals completely, there are things you can do to keep them to a minimum and reduce the impact they have on your business.

Analyse your reversal trends

Closely monitor why people are making payment reversals. For example, if customers are repeatedly claiming that the item they receive doesn’t look like it does on your website, it may be time for some new, more accurate product listings.

Make payments secure

Make sure your payment process is as secure as possible to avoid claims of fraudulent transactions that result in payment reversals. Consider implementing a two-factor authorisation for online orders and use recommended and reliable credit card readers and payment processors to ensure your transactions cannot be hacked or infiltrated by third parties.

Be attentive

Sometimes a payment reversal is necessary due to human error, such as inputting the wrong payment amount, accidentally charging a customer twice, or confirming an order for a sold-out item. Pay close attention to every transaction, keep an up-to-date stock inventory, and use transaction identifiers such as order numbers to help prevent human error.

Final thoughts on payment reversals

Payment reversals cover a range of different transaction types, including chargebacks and refunds.

Each type of payment reversal has an impact on your small business. The key to avoiding them is to be prepared and to act quickly when problems arise.

While you’ll never totally eradicate all payment reversals, you can implement the tips we’ve mentioned in this article to avoid them as much as possible.

Lucy Nixon - content writer

With 10 years experience in the digital marketing industry, Lucy is a content writer specialising in ecommerce, website building and all things small business. Her passion is breaking down tricky topics into digestible and engaging content for readers. She's also committed to uncovering the best platforms, tools, and strategies, researching meticulously to providing hand-on tips and advice.