If you’ve ever paid employees or received a paycheck through electronic deposit, then you’ve used the ACH payment system. Same with using the “pay bills” feature from your bank account. Whether you are aware of it or not, you use ACH to make payments every day.
In fact, even when a payment is not called an ACH transaction, a portion of that process might still pass through the ACH network. This is because ACH payments form the backbone of money transfer between US banks.
This article is meant to give you a quick introduction to ACH transfers. We have longer articles elsewhere if you want to do a deeper dive, but if you’re short on time, we hope this article at least gives you a general framework on what an ACH transfer is and how it works.
What Does ACH Stand For?
ACH stands for Automated Clearing House…which doesn’t mean anything by itself. ACH transfers are run by an organization called Nacha (in the past, it went by the acronym NACHA, which stands for the National Automated Clearing House Association). The association is responsible for making the rules related to how to make an ACH transfer, even down to the file transfer format a bank must use to transmit the information. It also interfaces with the US federal government, even trying to convince the US Federal Reserve to change its daily operations to make ACH transfers easier/faster for the banks.
Note that Nacha is an organization of/for US banks. While ACH transfers are possible outside the US, they are mostly used by banks in the US, and so Nacha rules mostly work only within the US.
Sometimes, people confuse ACH with eChecks, but they’re not the same. We have an article explaining eChecks in more detail, but, briefly, eChecks typically start as actual physical checks. They’re digitized (e.g. you take a photo of the check to deposit it to your bank account) and then the bank of the payor transfers that amount to the bank of the payee.
(This is where eChecks and ACH payments sometimes get confused. When the banks transfer that money, they could do it over the ACH network or they could do it over the Check 21 network. The precise network used depends on the bank’s preference. Just remember that, for pure ACH payments that started out as ACH payments, they will always go over the ACH network.)
How Does An ACH Transaction Work?
ACH transactions basically form the backbone of money transfer between banks in the US. These transactions are sent over a private computer network called the ACH network, which connects US banks to the US Federal Reserve Bank. The Federal Reserve is where money exchange between all the banks occur; right now, this is done twice a day during regular business days. This means that each bank must keep track of which customer sends how much money to which other person at what other bank until it’s time to send that information to the Federal Reserve at the designated settlement times. The Federal Reserve then makes the actual money transfer between the banks. Here’s an article with a more detailed explanation of the mechanics of money transfer between banks.
Note that ACH transfers can occur between a US bank and a foreign bank. In that case, the transfer information is passed through a different computer network — typically the SWIFT network on which most US-foreign transactions are sent through. These transactions use ACH transfer rules set up by Nacha, and that’s why they’re still called ACH transfers.
From a user’s standpoint, there are two types of ACH transfers: ACH credit and ACH debit. We will briefly explain the two below.
What Is An ACH Credit?
ACH credit payments are often thought of as “push” payments, where money is pushed out of the owner’s account. In other words, the sender of the money must authorize each payment before the money is transferred out.
The recipient of an ACH credit payment first gives the sender their bank account number and bank routing number. The sender then sends the recipient’s bank information to their own bank, along with instructions to pay a certain amount (sometimes, on a specific date). The payment information is batched and then sent to the central bank for settling according to a daily schedule. Once the transfer is settled, the money shows up in the recipientâs account. This type of payment is better suited for payroll or occasional bill payments where you want to control when and how much to pay.
What Is An ACH Debit?
With ACH debit payments, money is “pulled” from an account according to a set schedule. This type of payment is better suited for recurring bills such as utility payments, subscription plans, and similar. With ACH debit, the payor sends the information to the entity where payment is due (e.g., the utility company). The information includes account number, routing number, and payment authorization for a certain date of each month. On that date, the recipient of the payment sends a payment request to their own bank. That bank sends the information through the Federal Reserve to the payorâs bank, which checks for previous authorization and ensures there are sufficient funds in the account. If there are sufficient funds, then the payorâs bank releases the money.
ACH Payment Processing Times
ACH transfers are processed in batches, for efficiency. As of this writing, the Federal Reserve batches payments twice each working day, and Nacha hopes to be able to do three batches per day by 2021. Because of the batching times, ACH transfers can technically be completed on the same day, but typically you’ll have to pay an extra fee for the speed/jump ahead in line. If you do not wish to pay the extra fee, then the bank gets to decide when to make the transfer, and that means the transfer will take at least 24 hours.
Now, some money transfer services, such as Zelle, basically allow for instant transfers, once the account is set up. If ACH is the backbone money transfer service between banks, how do these services almost instantaneously transfer money? The answer is that they don’t. To you, the user and the recipient of the money, the money transfer seems instantaneous. But your bank is actually just lending you the money. The actual exchange of money between the two banks occur over the ACH network and is completed a few days later.
Why Use ACH Payments?
ACH payments typically cost less to process than credit card charges. What’s more, it’s also harder for the payor to dispute the payment and pull it back, once the payment is finalized. And, of course, despite the popularity of credit cards, not everyone wants to use them/can qualify for them. For these reasons, it might be worth your while to look into allowing your customers to pay through ACH payments.
ACH payments are not the best form of payment for all purchases. They are, however, especially suited for recurring payments such as payroll, utilities, installment payments of any sort, subscriptions, and the like, where a certain amount is due on a certain date each month. From a merchant’s standpoint, the money is pulled from the payor’s account always on a certain date, and from a payor’s standpoint, the money is paid on a designated date without fear that it might get lost in the mail.
Are ACH Payments The Best Payment Option?
Like everything in life, one size doesn’t fit all, and so it is with ACH payments. Although they’re well suited for some types of payments, they are not always the best option for others. For instance, for retail purchases where the customer buys an item and wants to take the item home right away, an ACH payment is not suitable. Credit or debit cards are the better form of payment under those circumstances.
However, ACH payments are well-suited for routine and recurring payments. From the merchant’s standpoint, ACH payments tend to cost less to process than credit card payments and, once they’re scheduled, they’re paid on a regular basis, often without the payor needing to pay attention to the process. Finally, ACH payments are harder to pull back, once the transfer is completed. This means that the merchant would have to deal with chargebacks a lot less.
If you wish to learn more about ACH and other forms of payment, we have other more detailed articles summarizing these. If you have any questions, please leave us a note below. We will do our best to help.
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