What is Chargeback Fraud & How to Prevent it

I’ve dealt with chargeback fraud before as an e-commerce store owner and want to help prevent your store from becoming a victim.

Thus, I’ll explain what chargeback fraud is, the different types, and how to prevent it. From there, I’ll provide additional information to help you learn everything about this type of fraud.

Let’s learn how much of an impact chargeback fraud makes.

Key Takeaways

• Chargeback fraud is when a customer lies to their bank to get money back for a legitimate purchase.
• This can hurt businesses financially and damage their reputation.
• Businesses can prevent chargeback fraud by using clear billing descriptors, address verification, and fraud detection tools.
• Subscription-based businesses, online retailers, and businesses selling high-value items are the most vulnerable to chargeback fraud.
• There are 2 main types of chargeback fraud: friendly fraud (accidental or intentional) and deliberate fraud (always intentional).
• Other types of chargeback fraud include: digital good chargebacks, subscription fraud, and return fraud.

What Is Chargeback Fraud?

Also known as:

• Cyber shoplifting
• Friendly fraud
• Liar-buyer fraud

Chargeback fraud occurs when a customer intentionally lies to their bank to reverse a legitimate purchase and obtain a forced refund (chargeback). For instance, the customer could have claimed merchant error as a reason for a chargeback.

This type of fraud happens because a customer wants something for free, regrets a purchase, or wants to exploit a business.

Anyone purchasing with a debit or credit card can commit chargeback fraud. This fraud could come from the shopper themselves or someone who uses the card without permission. Like a family member or an acquaintance.

In that case, you could consider it regular friendly fraud since the customer unknowingly committed fraud.

Summary: Chargeback fraud involves a customer or third-party using stolen card information falsely obtaining a refund by lying about the legitimacy of a transaction, often motivated by a desire for free goods, buyer's remorse, or criminal profit.

How Does Chargeback Fraud Work?

Here's how the process works for an instance of chargeback fraud:

1. Customer Files a Claim: The customer contacts their bank to initiate a chargeback.
2. Bank Investigates: The bank reviews the customer's claim and contacts the business.
3. Business Provides Evidence: The business must gather proof of the legitimate transaction (order details, delivery confirmation, communication with the customer).
4. Bank Makes a Decision: The bank either sides with the customer (chargeback granted) or the business (chargeback denied).

This is basically the chargeback dispute process. There’s a lot more complexity to it, which we clear up in a separate guide.

With return fraud, the cardholder might first attempt a fraudulent return directly with the business. If the seller refuses, the shopper can then escalate the matter to a chargeback claim with their bank. Following the same process outlined above.

If the merchant went through with the faulty return (without escalating to a chargeback) we’d consider that as refund abuse.

Summary: Chargeback fraud involves a customer falsely disputing a legitimate transaction with their bank.

Accidental vs. Deliberate Chargeback Fraud

Accidental chargeback occurs when a customer disputes a charge without intending to defraud the business. This could happen because they don't recognize the charge on their statement or genuinely forgot about the purchase (friendly fraud).

In many cases, the consumer may not actually know the differences between a refund and a chargeback. 72% of recorded buyers' responses suggest they don’t know.

Before getting into the world of e-commerce, I didn’t know.

Deliberate chargeback fraud is when a shopper intentionally lies to their bank to get an unfair refund. They know the charge is legitimate, but want to get something for free or abuse the return policy.

Here are examples of each:

• Accidental: A customer purchased a subscription to an online service months ago. The service has a generic billing descriptor the customer doesn't recognize. They see the recurring charge on their statement and dispute it, thinking it's an unauthorized transaction.
• Deliberate: A customer buys a dress, wears it to an event, and then claims it never arrived to get their money back.

Summary: Accidental chargebacks stem from customer confusion or error, while deliberate chargeback fraud involves intentional deception for personal gain.

Types of Chargeback Fraud

The following sections will expand upon these types of chargeback fraud:

• Friendly Fraud: A less malicious version of chargeback fraud.
• Digital Goods Chargebacks: Customer claims they’re unable to use digital products and initiates a chargeback.
• Subscription Fraud: Forces refunds and gets free subscriptions.
• Return Fraud: Abuses a store’s return policy and forces refunds through chargebacks.

Most of the examples below have the same definition as chargeback fraud, but involve different monetization types of items.

Let’s find out what types of chargeback fraud we should worry about.

1. Friendly Fraud

Friendly fraud is a broad term for when a customer gets a forced refund through deceptive or unfair means.

Chargeback fraud is a specific type of friendly fraud. It's always intentional: the customer knowingly lies to their bank to get a refund.

Here's an example:

• A customer buys a new phone and claims it never arrived (chargeback fraud).
• The cardholder buys a dress, wears it, and then returns it as unused (friendly fraud, but not necessarily chargeback fraud).

Both cases defraud the business, but only the first involves a chargeback.

Summary: Friendly fraud is an umbrella term covering accidental and intentional unfair refunds, while chargeback fraud is a specific subset always involving deliberate deception to the customer's bank.

Friendly Fraud vs. Chargeback Fraud

Similarities:

• Result in a customer getting a refund for a purchase they don't intend to pay for.
• Can cause financial loss for businesses.

Differences:

Intent: Friendly fraud can be intentional (like a customer lying about a product) or unintentional (like forgetting about a purchase). Chargeback fraud is always intentional deception.

Method: Friendly fraud doesn't always involve a chargeback. Buyers might use the business's return policy instead. Think refund abuse. Chargeback fraud always involves a customer lying to their bank to force a refund.

Summary: Both involve getting money back unfairly. Friendly fraud can be unintentional and doesn't always involve a chargeback, while chargeback fraud is always intentional and relies on deceiving the bank.

2. Digital-Goods Chargebacks

Digital-goods chargebacks occur when a customer purchases something digital and then disputes the charge to get a refund. These include things like downloadable software, subscriptions, in-app purchases, e-books, and music.

It’s the same as chargeback fraud but with the word “digital-goods.”

These chargebacks work by the shopper falsely claiming to their bank that they never received the product, didn't authorize the purchase, or that it was defective.

Examples of digital goods chargebacks include customers doing the following:

• Buys a game online, downloads it, and claims non-delivery.
• Signs up for a subscription service and cancels after a month but claims it was unauthorized.
• Makes in-app purchases in a mobile game, then files a chargeback, often through a child's account.

Summary: Digital goods chargebacks are fraudulent disputes where a customer receives a digital product or service and then lies to their bank to get a refund.

3. Subscription Fraud

Subscription fraud happens when a user disputes a charge for a subscription service after using it for a long time.

It’s likely not forgetful at this point (considering the duration). Thus, they’re trying to game the system.

Summary: Subscription fraud involves exploiting free trials and subscriptions through false identities or repeated abuse of promotions to obtain products or services without intending to pay.

4. Return Fraud

Return fraud is when a customer abuses a business's return policy to get a refund they don't deserve. It's a type of chargeback fraud because shoppers often falsely claim something is wrong with the product to get their money back.

Wait. If you read our post on friendly fraud, wouldn’t this just be refund abuse?

Nope.

Refund abuse is a subset of friendly fraud focused on exploiting return policies, but doesn't involve lying to the customer's bank. It focuses on customer/business interactions. Whereas, return fraud focuses on communication between the customers and their banks.

Refund abuse might never escalate to a chargeback.

Return fraud can involve lying to the store directly, but often escalates to a chargeback if the merchant refuses a fraudulent return attempt.

Summary: Return fraud involves exploiting a business's return policy by returning used, damaged, counterfeit, or stolen items for a refund, often by escalating to a chargeback claim with their bank.

How to Prevent Chargeback Fraud

Here are some ways to prevent chargeback fraud:

1. Clear Communication:

Use clear billing descriptors consumers will recognize on their statements. They should also have easily accessible, detailed return and refund policies.

Providing clear contact information for customer service encourages resolution attempts before a shopper resorts to a chargeback.

For detailed refund and return policies, consider the following:

• Specific Timeframe: State the exact number of days a customer has for a return (e.g., "30 days from the date of purchase").
• Conditions for Return: Define acceptable conditions (unused, original packaging, tags attached).
• Restocking Fees: If applicable, state any restocking fees the buyer might incur.
• Exclusions: Mention any types of items not eligible for returns (e.g., custom-made products).

The more details provided, the less wiggle room a consumer has to abuse a business’ refund/return policy.

2. Address Verification (AVS)

AVS compares a customer's billing address with the address on file with their card issuer. Mismatches can indicate potential fraud.

Businesses can choose to decline transactions that fail AVS checks to mitigate risk.

3. Fraud Detection Tools

Specialized software helps analyze customer data and transaction patterns. It can flag suspicious activity like multiple orders from the same customer with differing shipping addresses.

This allows for closer scrutiny of potentially fraudulent orders before they ship.

4. Require Signature Confirmation:

For higher-value items or in areas with frequent delivery issues, require a signature upon delivery. This provides proof of receipt, making it harder for a customer to claim "non-delivery" falsely.

What’s considered a “higher-value item”?

Think of the average order value on your website. Consider above that average as "high-value". And think about the financial impact if a chargeback for that item succeeds.

If the potential loss is substantial, require a signature.

5. Documentation:

Maintain clear records of every transaction and communication with customers. This includes order details, shipping information, and any email or phone correspondence.

This evidence is crucial for fighting fraudulent chargebacks with the bank.

The more evidence a seller has, the more likely they are to win chargebacks.

How to Detect Chargeback Fraud (Red Flags)

Here are some red flags that might signal potential chargeback fraud:

• Multiple orders with different cards but the same shipping address.
• Rush orders, requests for overnight shipping, or unusual shipping requests.
• Large orders, especially for high-value items.
• Customer claims "item not received", but tracking information shows delivery.
• Cardholder ignores requests for more information or offers of replacement products.
• Billing addresses located in high-risk countries for fraud (e.g., Brazil).
• An unusual spike in returns from a particular customer or geographic location.
• A customer excessively contacting customer service to complain.
• A disregard for details, like the color of the product or other features.

Chargeback fraud is difficult to identify because customers mimic legitimate shopping behavior. There may not be any obvious indicators during the transaction itself. Fraudsters intentionally exploit a system designed to protect consumers.

This makes it challenging for businesses to distinguish between genuine customer dissatisfaction and intentional deception.

Summary: Red flags like multiple cards, unusual shipping requests, large orders, or inconsistencies in customer claims can indicate potential chargeback fraud.

Business Types Affected by Chargeback Fraud

Subscription-based businesses, online retailers and service providers, and those selling high-value items face heightened chargeback fraud risk due to factors like recurring charges, lack of in-person interaction, easily disputed digital goods, and the temptation of high-value products.

I’ll expand upon these business types and industries throughout the following sections.

Know your risk and keep reading.

1. Subscription-Based Businesses

They often operate with automatic recurring charges.

Customers might subscribe and forget to cancel, leading to disputes when they see the charges. This model allows for "buyer's remorse" chargebacks because a user might change their mind later and demand a refund for previous services they used.

Subscription-based businesses also have the lowest average chargeback win rate percentage for businesses at 49.1%. Whereas, businesses that primarily use single-purchase models have a 54.5% win rate.

This rate is still above the 43.82% win rate percentage that businesses have regarding friendly fraud cases in general [1]. But it’s still a factor to consider.

2. Online Retailers

They lack the face-to-face interactions that build rapport in a traditional shop.

‍This makes verification more difficult. Increasing the chance of mistaken chargebacks (customer doesn't recognize the purchase) or deliberate fraud (customer trying to get something for free).

Digital products are even more tricky because the shopper can claim non-delivery. And there's no physical proof of them receiving the product. Making it more difficult for businesses to win chargeback disputes.

SaaS and software product providers have a much higher chargeback rate than others (0.66%). Increasing their volatility.

3. Businesses Selling High-Value Items

These shops are tempting targets for fraudulent chargebacks due to the potential for a higher payout. 

Customers looking to get something for free might see an opportunity to obtain an expensive product. From there, they lie to their bank to claim it was never received or was unauthorized. These large transactions result in huge losses for the business if the chargeback is successful.

Businesses that typically sell high-end items (ex: jewelry and purses) have a much lower chance of winning chargeback disputes (27.64%). Compare that to the 46.85% win rate transactions less than $29.99 have.

How Businesses Suffer From Chargeback Fraud?

Here are ways chargeback fraud harms businesses:

• Lost Revenue: Businesses lose the money from the original sale.
• Loss of Merchandise: The business doesn't get the sold product back.
• Chargeback Fees: Banks charge fees for each chargeback incident.
• Time and Resources: Businesses spend resources investigating and fighting chargebacks.
• Reputational Damage: Too many chargebacks hurt a business's reputation with banks.
• Higher Fees: Businesses may face higher fees for payment processing in the future.
• Loss of Access to Payment Processors: Having too high of a chargeback rate for too long can cause the payment processor to break ties with the business.
• Money Hold: Payment processors like Stripe will hold funds; interrupting cash flow.

Summary: Chargeback fraud results in direct financial losses, wasted resources, reputational damage, and the potential for increased operational costs for businesses.

Chargeback Fraud vs. True Fraud Chargebacks

True fraud involves a criminal using a stolen credit card or account information. The legitimate cardholder doesn't know about the fraudulent charge until it’s too late. The business authorizes the purchase, and the customer is the victim.

Businesses have a 9.27% chance of winning true chargeback fraud disputes.

Chargeback fraud occurs when the actual cardholder intentionally lies about a legitimate transaction. They contact their bank claiming it was unauthorized, or the product was defective, to get their money back.

This type of fraud is driven by the customer's dishonesty, not criminal theft of their card information.

Considering this type of fraud falls under the umbrella of friendly fraud, businesses have a 43.82% chance of winning these chargebacks.

Here's an example:

• True Fraud: A thief finds your wallet and buys a laptop with your card.
• Chargeback Fraud: You buy a laptop, receive it, then claim it never arrived.

If you’re a business, the best way to improve your chances of winning disputes regarding both instances of fraud is by getting chargeback protection and prevention software. And possibly chargeback insurance.

Summary: True fraud involves criminal use of stolen payment information, while chargeback fraud involves the actual cardholder deceptively obtaining a refund for a legitimate purchase.

FAQs for Chargeback Fraud

Is Chargeback Fraud Illegal?

Yes. Chargeback fraud is illegal when the customer does it intentionally.

What’s the Difference Between Chargebacks & Refunds?

Chargebacks are bank-initiated reversals, while refunds are merchant-controlled returns.

What Happens if You Commit Chargeback Fraud?

Committing chargeback fraud can result in account closure and potential legal action against the customer.

Conclusion

Businesses can minimize the risk of fraudulent chargebacks by having clear communication, utilizing fraud detection tools, and maintaining detailed records.

Doing so protects their finances and safeguards their reputation with banks and future customers.

You should also consider deploying tools that prevent refunds from escalating to chargebacks. That’s where we come in. Learn how we can help.