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What is ACH Payment and How Is It Processed?

16 August, 2022
5mins read
Brett Johnson, AVP, Global Enablement
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What you'll learn

  • What is ACH payment?
  • What are the different categories of ACH payment and their types?
  • How does ACH payment work?
  • What are the pros and cons of ACH payments?
  • How long does ACH processing take, and what are its security requirements?
  • Steps to set up ACH payments
CONTENT
What is ACH (automated clearing house) payment?
What are the different categories of ACH payments? (Examples)
Types of ACH payments
How does ACH payment processing work?
What are the pros and cons of using ACH payments?
How long does ACH payment processing take?
What security requirements need to be fulfilled to receive ACH payments?
Steps to set up ACH payments
FAQs
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ACH stands for “Automated Clearing House.” It is an electronic payment medium used in the United States and some selected regions for sending money between bank accounts directly. In contrast, the EMEA countries have Single Euro Payments Area (SEPA) as an alternative to ACH. 

ACH payment uses its proprietary network and is also known as “direct payment” because cash, checks, and card networks like Visa and Mastercard are not involved.

In 2021, 29.1 billion payments worth more than $72.6 trillion were made using the ACH network. It is an increase of 8.7% from 2020 in volume and 17.4% in value.

Source: NACHA

What is ACH (automated clearing house) payment?

ACH payment is a direct electronic bank-to-bank transaction system. It doesn’t use cash, checks, or card networks. The National Automated Clearing House Association (NACHA) manages the ACH network and ensures that it is safe and easy to use.

Since ACH is a US-based payment system, it is not used outside the country except in some supported regions such as Guam, American Samoa, and the Northern Mariana Islands. This doesn’t mean the ACH network doesn’t support international transactions. However, wire transfers are a more effective way to make cross-border transactions due to their speed and convenience.

What are the different categories of ACH payments? (Examples)

ACH payments are of two main categories. They are:

  1. ACH credit
  2. ACH credit or direct deposits are a payment type where funds are transferred from the payee’s account to the receiver after they give the instructions to the ACH network. Here the payment is initiated from the sender’s side. The transaction cost for an ACH credit transfer is around $3 per transaction.

    An example of ACH credit would be when a company sends payroll to their employees at the end of every month. Since the funds move directly from the employer’s bank account to employees, it is categorized as ACH credit.

  3. ACH debit
  4. ACH debits happen when funds are pulled from the customer’s bank account with their approval. The business/receiver initiates the transaction in case of ACH debit. Unlike ACH credit which costs around $3 per transaction, ACH debit is generally free.

    For example, when a bank collects the EMIs for your house loan after a user approves it from their end, it is categorized as ACH debit.

Types of ACH payments

There are two primary types of ACH payments:

  1. Requested payments
  2. After your customer’s bank authorizes your business, it can request payments. Such payments need to be approved every time by the customer, giving them complete control over the transfer of funds.

  3. Automatic payments
  4. As the name suggests, these payments need to be approved only once by the customer and are deducted automatically after that. For example, your bank could deduct monthly EMIs for house loans on the due date after you approve them once. 

How does ACH payment processing work?

ACH payment processing involves a file with the details of the desired transaction. The file is first transferred to the user’s bank, which initiates the payment. After that, it goes to the clearing house and finally to the receiver’s bank account. Let’s look at the organizations involved in the process.

  1. Originating Depository Financial Institution (ODFI): It is the receiver’s bank where the transaction is first initiated. All the details regarding the transaction, such as routing number, bank details, and transaction type, are shared by the ODFI.
  2. Clearing House: The ODFI sends the ACH payments in batches to a clearing house or the Federal Reserve, which then forwards it to the RDFI.
  3. Receiving Depository Financial Institution (RDFI): Once the RDFI or the sender’s bank receives the transaction details from the clearing house, the funds are pulled from the customer/sender’s bank, and the transaction is completed.

What are the pros and cons of using ACH payments?

ACH payments are an easy and convenient way to make transactions in the United States. However, while there are benefits to using ACH as a payment method, there are also some disadvantages. Let’s take a look at the pros and cons of ACH payments.

pros and cons of using ACH payments

Pros

  1. Speed and convenience: The general timeline for ACH payments is 1 – 2 business days. It is much faster than the other standard payment methods that businesses use, like checks. The speed, tracking ability, reliability, and the absence of any physical steps make it a convenient method for B2B transactions.
  2. Security: ACH payments are secured by banks with high-level encryption techniques, making them much safer than checks. Since it is an electronic payment method, unlike checks, it cannot be interfered with by third parties easily. 
  3. Cost: ACH payments can cost you from a few cents to a few dollars, depending on the transaction size. When you compare it to wire transfers that have a transaction cost of atleast $15 or credit cards that also charge anywhere between 2% – 4%, ACH payments are not only fast but also cost-effective. These cost savings can soon add up for businesses that have huge transaction volumes.
  4. Room for automation: Businesses can automate ACH payment requests from customers and enable zero-touch cash posting with AR automation solutions such as the RadiusOne Cash Reconciliation app.

Cons

  1. Transaction Limit: A major downside to using ACH payment methods is the transaction limits. Banks may set daily, weekly, or monthly transaction limits on the ACH payments that can be made by a customer. 
  2. Timings: Unlike wire transfers that can process only one transaction at a time, ACH payments are processed in batches. The time gap between processing two batches varies from bank to bank. There are also cut-off times after which the transactions are only processed the next business day. So, checking with your bank about the timings is also essential.
  3. Penalties: If you do too many ACH transfers from your savings account, then banks could charge you a penalty. This happens because savings accounts in the US have a limit of six withdrawals per month.

How long does ACH payment processing take?

Unlike checks that can take up to a week to process, ACH payments are processed much faster. Most ACH transactions are settled within 1-2 business days. According to the rules set by NACHA, ACH debits must be cleared on the same day of payment or by the next business day. On the other hand, ACH credits have a 1-2 business day time frame. 

However, if your bank withholds payment for any reason, the total processing time of the ACH payment can take longer. 

What security requirements need to be fulfilled to receive ACH payments?

The National Automated Clearing House Association (NACHA) provides the rules and security requirements businesses must adhere to for using ACH payments. It ensures that sensitive ACH data is protected. So, if your business allows ACH payments or has plans to add the option in the future, here are the rules you must know about.

security requirements for ACH payments

1)  Secure all personal information

The NACHA states that any ‘non-public’ personal information (including financial data) and sensitive data like driver’s license number and social security number involved in an ACH transaction must be protected.  

2) Secure data transmission

All the data that is transmitted during an ACH transaction must be encrypted with a ‘commercially reasonable’ encryption technology. So, sending or collecting sensitive data by regular email or a web form isn’t allowed. If your business uses a website or third party to collect sensitive information from customers, it must have a security certificate or strong encryption technology.

3) Validate routing number and identity

NACHA recommends that businesses take necessary steps to ensure that the routing number added to the ACH network is valid. And in case the authorization for a transaction happens verbally or over the web, businesses need to take the necessary steps to identify the customer’s identity.

4) Detect fraudulent transactions 

Businesses should implement the necessary systems to identify irregularities and prevent fraud. This makes it essential to choose a payment processing system with a robust mechanism for detecting fraudulent transactions.

Here is an article by NACHA stating the security requirements for ACH payments.

Steps to set up ACH payments

  1. Create an account and select a payment processor to handle your ACH payments. The documents that are required to open a new account are:
    • Federal Tax ID
    • Proof of company address
    • ID of company owners
    • Approximate processing volume
  2. Go through the paperwork involved and ensure you understand the terms and conditions. You also need to comply with the rules and regulations that the payment processor has in place.
  3. After you submit the details and complete all the formalities, the system will fetch your details. It can take up to a week for your new ACH account to be opened.

Now that your business has an ACH account, you can accept payments from your customers by asking them to authorize ACH debits from their bank account. Some details that you will need to collect as a business to initiate an ACH debit transaction are:

  • Name
  • Account number and type
  • ABA number
  • Transaction amount

HighRadius’s RadiusOne eInvoicing & Collections application can help you set up ACH payments for your business along with several other payment methods. It also allows you to offer a superior customer experience by giving clients a centralized place to manage their invoices, account statements and make payments.  

FAQs

  1. Is ACH the same as a bank transfer?
  2. ACH payments are different from bank transfers as they often take more time to be processed but are cheaper, more secure, and convenient. Additionally, ACH payments use its proprietary ACH network.

  3. Is ACH processed on weekends?
  4. ACH payments are not processed on weekends and when the Federal Reserve system is closed. So, the transaction timings are limited to business working days.

  5. What is the ACH transfer limit?
  6. ACH transfer limits vary from bank to bank and also depend on the type of account a user has. However, the top limit of ACH payments for same-day transactions is now $1 million.

  7. Is ACH safe?
  8. ACH payments are safe, and since they are reversible within a fixed time period, it reduces the risk of any liability if a fraudulent transaction occurs.

  9. What time do banks start processing ACH transactions? 
  10. Banks have different processing timings for ACH transactions, and since they are processed in batches, the time gap between them may also vary. 

  11. Do ACH payments always go through?
  12. Unless there is a lack of sufficient funds in the sender’s account or they inform the bank of a fraudulent transaction, an ACH payment will go through.

  13. Are there any penalty fees with ACH payments?
  14. ACH payments aren’t expensive and can cost anywhere from a few cents to $2-$3 per transaction. But, there can be penalty fees associated with ACH payments in case a sender exceeds the daily, weekly, or monthly limit of their bank account.

  15. How much does it cost to process ACH payment?
  16. The transaction costs for ACH payments are extremely low and are often below $3. Some banks charge a flat fee while others charge a percentage fee which is often higher than the former. 

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