What Are ACH Payments and How Do ACH Transactions Work?

What does ACH payment mean? (photo: SmartAsset.com)

An ACH payment refers to the process of transferring money electronically between two bank accounts in the United States through the Automated Clearing House network. ACH payments, also known as direct payments, provide a way to transfer funds without the use of paper checks, cash, credit card networks, or wire transfers.

The use of ACH payments has been steadily increasing, with the network processing more than 25 billion electronic payments in 2016, worth a total of $43 trillion. This represents a five percent increase from the previous year.

Many consumers are likely already familiar with ACH payments, even if they are not familiar with the term. For example, if you pay your bills electronically or receive direct deposit from your employer, it is likely that the ACH network is involved in the transaction.

For businesses, ACH payments are a popular alternative to paper checks and credit card payments because they are faster, more reliable, and less expensive to process. This can help businesses automate and streamline their accounting processes and generate significant savings, particularly for those that accept recurring payments.

Quick ACH fact sheet:

Applicable accounts	Checking and savings accounts only
Areas of operation	United States and Puerto Rico
Governing body	NACHA (The Electronic Payments Association)
Typical processing times	Fund become available within about three to five business days

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What are the differences between ACH payments, wire transfers, and EFT payments?

While ACH payments, wire transfers, and EFT payments all involve electronically transferring funds between accounts, there are significant differences among them. Wire transfers are processed in real time, while ACH payments are processed in batches several times a day, resulting in longer processing times. As a result, wire transfer funds arrive on the same day, while ACH payments can take several days to clear. Wire transfers are also more expensive than ACH payments, with some banks charging up to $60 per transfer.

EFT payments, which stands for electronic funds transfer, can be used interchangeably with ACH payments. Both terms describe the same payment mechanism, where funds are electronically transferred between accounts.

:-:	ACH Payments (also called EFT)	Wire Payments
Pros	Cost: ACH payments tend to be cheaper than wire transfers	Speed: faster since they do not use a “batch” process
Cons	Speed: ACH payments can take several days to process	Cost: relatively expensive

_{source: http://www.finance.umich.edu/node/2149}

What are some examples of ACH payments?

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ACH payments can be classified into two types: ACH debit transactions, which pull money from an account, and ACH credit transactions, which allow for pushing money to different banks. Here are two examples of how ACH payments are used:

- Direct deposit payroll 

Many companies offer direct deposit payroll, using ACH credit transactions to push money to their employees' bank accounts on designated pay periods. Employees typically need to provide a voided check or a checking account and routing number to set up direct deposit.

- Recurring bill payments 

Consumers who make regular payments to businesses, such as insurance providers or mortgage lenders, may choose to sign up for recurring payments. This allows the business to initiate ACH debit transactions at each billing cycle, pulling the amount owed directly from the customer's account.

How do ACH payments work?

Apart from the Automated Clearing House network that connects all banks in the United States, there are three other key players involved in ACH payments:

- The Originating Depository Financial Institution (ODFI) is the bank that initiates the transaction.

- The Receiving Depository Financial Institution (RDFI) is the bank that receives the ACH request.

- The National Automated Clearing House Association (NACHA) is a nonpartisan governmental entity responsible for overseeing and regulating the ACH network.

How do ACH payments work?

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Let's use automated monthly phone bill payments as an example. When you sign up for autopay with your phone company, you provide your checking account information, including routing and account numbers, and sign a recurring payment authorization.

When your billing cycle is due, your phone company's bank, the Originating Depository Financial Institution (ODFI), sends a request to your bank, the Receiving Depository Financial Institution (RDFI), to transfer the owed amount. The two banks then communicate to ensure that there are enough funds in your bank account to process the transaction.

If you have enough funds, the transaction is processed, and the money is sent to your phone company's bank account.

How long does it take for ACH payments to process?

ACH payments usually take a few business days to complete, as the processing occurs in batches rather than in real-time like wire transfers. According to NACHA's guidelines, financial institutions can choose to process and deliver ACH credits within one business day or within one to two business days. ACH debit transactions, on the other hand, must be processed by the following business day.

Additionally, the receiving bank may hold the transferred funds for a specific period of time. Overall, the average processing time for ACH payments is typically three to five business days.

However, a new NACHA rule implemented in September 2016 requires ACH debits to be processed three times a day instead of just once. This change will enable widespread use of same-day ACH payments by March 2018, and the implementation is occurring in phases.

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What causes ACH payments to be rejected?

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When an ACH payment is rejected, the bank that originated the payment will provide a reject code that explains why the payment did not go through. These codes are important for communicating to customers the reason for the rejection. The following are the four most common reject codes:

R01 - Insufficient funds: This code indicates that the customer did not have enough money in their account to cover the amount of the debit entry. To resolve this, the transaction will need to be retried after the customer transfers more money into their account or uses a different payment method.

R02 - Bank account closed: This code indicates that the customer had previously closed the bank account linked to the payment. The customer will need to provide a new bank account for the transaction to be processed.

R03 - No bank account/unable to locate account: This code is triggered when the account number and name on the account provided by the customer do not match the bank's records or when a nonexistent account number is entered. The customer will need to verify and provide accurate banking details.

R29 - Rejected: This code is issued when a bank does not allow a business to withdraw funds from a particular bank account. To resolve this, the customer will need to provide the ACH Originator ID to their bank to enable ACH withdrawals by the business. The transaction can then be retried.

Does using ACH payments come with penalty fees?

Regrettably, if an ACH payment is rejected, your business may incur a penalty fee. Thus, it is crucial to resolve any issues promptly to avoid incurring extra fees during subsequent billing cycles. To avoid the trouble of dealing with ACH rejects, it may be worthwhile to only accept ACH payments from customers that you trust.

What measures are in place to ensure ACH security?

Although the ACH network is overseen by the federal government and NACHA, ACH payments are not subject to the same PCI-compliance regulations that govern credit card processing.

Nevertheless, NACHA mandates that all parties involved in ACH transactions (including businesses initiating payments and third-party processors) establish processes, procedures, and controls to safeguard sensitive data. Their guidelines also require that any transmission of banking information (such as a customer's account and routing number) be encrypted using "commercially reasonable" technology.

Consequently, it is prohibited to send or receive bank information via unencrypted email or insecure web forms. If you employ a third-party ACH payment processor, ensure that they utilize state-of-the-art encryption techniques.

In compliance with NACHA's regulations, ACH payment originators must take "commercially reasonable" measures to authenticate customer identity and routing numbers and detect potential fraudulent activity. Most third-party ACH processors should possess these capabilities, but it's advisable to verify before partnering with any of them. Additionally, it's wise to work with an IT or security expert to ensure that your business processes ACH payments securely.

- The benefits of ACH payment processing

ACH payment processing offers several benefits that make it an attractive option for businesses. Firstly, it generally incurs lower processing costs than other payment methods, especially if a provider with a flat rate is used. This means that businesses can save money on transaction fees, which can add up over time.

Another advantage of ACH payments is that there are fewer declines due to expiration since checking accounts don't have expiration dates like credit and debit cards. This can help ensure that transactions go through smoothly and reduce the time and effort needed to follow up on failed payments.

Finally, ACH payments can be more convenient for businesses as they eliminate the need for paper invoices and checks. This can save time and money on printing and mailing costs, as well as reducing the need for trips to the bank to deposit checks.

Offering various payment choices enhances the customer experience. ACH payments eliminate the need for customers to look for their checkbook every month, and they can simply sign up for recurring billing, making it a "set it and forget it" experience.

- The drawbacks of ACH payment processing

While ACH payment processing is a cost-effective and convenient option, it has some limitations worth noting.

Speed ACH payments take longer to process compared to other payment methods, usually between three to five business days.

Caps There are daily and monthly caps on the amount of money that can be transferred through ACH payments. For Same Day ACH, there is a maximum transfer limit of $25,000.

Cutoff times ACH transfers initiated after a certain time of day will not be processed until the next business day or Monday if it falls on a weekend.

U.S. only ACH transfers are limited to banks in the United States, and cannot be made to or from international bank accounts.

How to accept ACH payments at your small business

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Small businesses can accept ACH payments by using a bank or payments processor that is set up to run ACH payments since they are not set up by NACHA to be the ODFI or the RDFI in an ACH transaction. Square, for example, utilizes ACH to deposit the funds that businesses process through Square into their linked bank account quickly. Square Payroll and Square Loans also use ACH payment processing to pay employees and deposit funds into sellers’ accounts. ACH transfers are batched and deposited on a set cadence, and Square ACH deposits are available as soon as the next business day. If the close of day is set to 5 p.m. PT or earlier (the default), the funds will arrive in the bank account by the next business day. If the close of day is set after 5 p.m. PT, the funds will arrive within two business days. Businesses can track their deposits to learn more.

Want to get paid faster? Try Instant Transfer

If you need your money faster than next-day deposits, you can opt for Square’s Instant Transfer service. With Instant Transfer, you can move funds to your bank account immediately. You can transfer up to $10,000 per transfer, 24/7, for a fee of 1.5% of the transfer amount.

If you have a Square Checking account, you can use its account and routing numbers for inbound and outbound transfers. You can also use your account and routing numbers to allow third parties to debit your Square Balance via ACH to make payments for bills or expenses at no additional cost. Moreover, you can deposit funds into your Square Balance via ACH. Note that the transfer limits may vary for new Square sellers.

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Source: https://squareup.com