ACH Payments: What Are They and How Do They Work?
If you’ve been looking into new ways to make electronic payments, you’ve likely encountered ACH payments.
There are several different methods for electronic money transfers, but not all methods are created equally in terms of security, fees and convenience.
For more information on ACH payments and how they work, keep reading for everything you need.
What are ACH payments?
ACH is the acronym for Automated Clearing House. An ACH payment is a store-and-forward system that electronically moves funds. ACH is a type of authorization that permits the lender to retrieve money from your credit card account, bank or credit union through an electronic process.
For a payment to be authorized by the ACH, it must be a part of the Automated Clearing House Network. A financial institution member of the ACH holds credibility because it has been vetted thoroughly.
ACH is a cost-effective way to move funds because it eliminates the middleman process of writing paper checks or completing a wire transfer.
Millions of people use ACH payments every year, including:
- Federal government
- State government
- Local government
If you’ve ever received a direct depositpaycheck, made an online bill payment, or signed up for autopay, you’ve participated in an ACH transaction. Although you might not have heard the name before, ACH payments are one of U.S. citizens’ most common payment methods.
Last year 29.1 billion payments adding up to $72.6 trillion, were reported by the National Automated Clearing House Association (NACHA). Those numbers are an 8.7%increase from 2020, and this year’s projections are higher than ever.
How ACH payments work: a step-by-step guide
The ACH process is a system of electronic fund transfers from one entity to another. There are several involved parties, even though most work behind the scenes to complete the seamless transfer.
This entity, such as a consumer or business, has agreed to participate in transactions through the payment system. Originators must consent to the transaction before it can occur.
2. Originating depository financial institution (ODFI)
Once an originator consents to the transaction, their financial institution will receive their payment instructions and send that information to the ACH Operator. This includes payment type, amount and payment schedule.
3. ACH operator
The ACH operator is a central clearing facility that receives payment information and instructions from the ODFI.
The Federal Reserve Bank and the Automated Clearing House are both ACH Operators. The ACH Operator performs the necessary settlement functions before the transaction can proceed.
4. Receiving depository financial institution (RDFI)
Once the ACH Operator has cleared the transaction, it is forwarded to the RDFI, the receiving financial institution. The RDFI’s job is to post the transaction into the receiver’s account.
The receiver is the entity, such as a corporation or entity, which has authorized the originator to complete the ACH deposit into the receiver’s account.
Third-party service provider
While not always a part of the process, a Third Party Service Provider is an entity that carries out ACH Network duties for originators, ODFIs or RDFIs.
Third-Party Service providers perform functions like:
- Creating ACH files for an originator or ODFI
- Acting as sending or receiving point for an ODFI or RDFI
As a subsection of a third-party service provider, this entity transmits ACH deposits for originators with no ODFI contractual agreement.
Types of ACH payments
ACH credits happen when the originator passes funds into the receiver’s account, the receiver’s account is then credited and the originator’s account is debited.
This type of entry is considered an offset or settlement. The most common type of ACH credit is a payroll direct deposit.
ACH debits occur when the funds are pulled from the receiver’s account with the RDFI, the receiver’s account is debited, and the originator’s account is credited.
This type of entry is also considered an offset or settlement. Common types of ACH debit are insurance premium payments and utility bills.
Depending on the receiver’s account type, an ACH entry is a consumer or non-consumer payment. It is up to the originator to determine the type of account, consumer or business, that they have secured for authorization.
Before any entity can participate in ACH transactions, they must complete account authorization.
Standard account authorization methods are:
- Prenotifications with routing number and account number (a non-monetary entry that comes to the checking account or savings account before the first actual entry)
- Social security
- Proof of ownership
- Proof of address
Related: How to Maximize Your Social Security
Types of ACH transactions
When it comes to ACH transactions, there are both corporate, and consumer transaction types:
- Corporate transactions happen between non-consumer entities, like businesses and corporations.
- Consumer transitionsare between originators and individual consumers. Take a look below for more information on each.
Corporate credit or debit (CCD)
A CCD entry is either a single-entry, recurring ACH credit, or recurring ACH debit from a corporate account. It can hold one single addenda record.
CCDs have many different uses for originators, which include:
- Paying vendors
- Concentrating funds from outlying accounts (cash concentration)
- Funding payroll
- Funding petty cash
- Funding other disbursement accounts
Corporate trade exchange (CTX)
A CTX entry is a single-entry, recurring ACH credit or ACH debit. However, a CTX coming from a corporate account can support up to 9,999 addenda records. Corporate Trade Exchanges are generally used in partner trading correspondence.
Prearranged payment and deposit (PPD)
A PPD is a single-entry, recurring ACH credit or recurring ACH debit. These transactions happen between an originator and a consumer to make or collect an authorized payment.
Internet-initiated/mobile entries (WEB)
A WEB is a single-entry or recurring ACH debit. These transactions are digital, occurring when the consumer authorizes a transfer of funds with their online account or mobile device.
Telephone-initiated transactions (TEL)
A TEL is a single-entry or recurring ACH debit. These transactions are based on telephone authorization given by the consumer.
Pros and cons of ACH payments
Before you implement ACH payments into your business or opt-in for them in your personal life, make sure you have a complete picture of what they entail with their pros and cons.
Pros of ACH payments:
Benefits of ACH payments may include:
- Convenience:ACH debit allows automatic recurring payments, which cuts paperwork and manual payments each pay period.
- Accuracy: Using electronic automation reduces the margin for human error.
- Cost: ACH processing fees are lower than credit card, debit card and wire transfer fees.
- Security: The nature of ACH regulations and ACH payment confidentiality makes ACH transfers between accounts more secure than credit card payments and wire transfers.
Related: Credit Card Industry Terms Defined
Cons of ACH payments
Drawbacks of ACH payments may include:
- U.S. exclusive: In this regard, wire transfers have the upper hand, as ACH payments cannot be made to or from international bank accounts.
- Payment processing times: Because ACH payments occur in batches and go through a clearinghouse, ACH credit transactions can take up to three business days to process. However, debit transactions must be processed the next day, and other transactions are eligible for same-day processing.
- Transaction limits: Different banks have different guidelines for transaction amounts, but many have limits — per transaction, daily, weekly or monthly.
- Potential for payroll fraud: While automation saves time and reduces human error, it does mean that a physical person is not checking payroll amount each month. This allows room for employees to wrongfully inflate their hours or create fraudulent accounts while going unnoticed.
Should you implement ACH payments?
Automated Clearing House payments are secure electronic payments authorized by the National Automated Clearing House Association. The ACH is a payment processor that can approve, vet, push, and pull transactions from business to business and business to individual.
Implementing an ACH system can be a prudent payment method option to cut the hassle and boost the use of automated bank transfers, as long as you are not looking for a same-day processing option.
The author of 5 books, 3 of which are New York Times bestsellers. I’ve been published in more than 100 newspapers and magazines and am a frequent commentator on NPR.