What are ACH Payments and How Do They Work?

Account Guide

min read

An ACH payment is an electronic bank-to-bank payment made through the Automated Clearing House (ACH) Network. The ACH Network, on the other hand, is a system run by NACHA (National Automated Clearinghouse Association) — a body regulated by the US federal government — that facilitates all ACH transactions and represents over 10,000 financial institutions.

Key takeaways:

An ACH transfer is an electronic funds transfer payment system that allows users to make deposits and payments through the ACH Network.
ACH payments have better security, a low cost, convenience, and a short processing time.
An ACH credit allows users “push” funds into an account; an ACH debit allows users to “pull” funds from an account.

What is an ACH Transfer?

ACH, which stands for Automated Clearing House, is a network used to send and receive money between bank accounts. This payment system, which uses the ACH Network, was established in the 1960s to process financial transactions for businesses, consumers, as well as federal, state, and local governments.

In 2022, this system has processed over 30 billion transactions and over $73 trillion USD, according to NACHA. It’s also one of the most popular types of electronic bank transfers used for transactions, such as external fund transfers, direct deposits, international payments, and automatic bill payments.

Precisely, there are two types of ACH transfers:

ACH Direct Deposits

An ACH direct deposit is any form of deposit payment from an organisation (a business or the government) to a consumer. It includes, but is not limited to:

Payroll
Employee expense reimbursement
Tax returns
Government benefits
Interest payments
Annuity payments

As the name implies, with ACH direct deposits, you’re receiving money. On the contrary, when you’re sending money, you’re making an ACH direct payment.

ACH Direct Payments

Any organisations (businesses or organisations) and individuals can use ACH direct payments to make a transaction. Typically, direct payments are used for bill payments, paying a service provider or a supplier, or any charges paid to the government.

In an ACH direct payment, the sender is referred to as “ACH debit” while the beneficiary party is referred to as “ACH credit”.

🔑

How does an ACH Transfer work?

In an ACH transfer, funds are transferred from one bank account to another. This transaction is essentially a data file that contains information/instructions about the payment.

The process of a typical ACH transaction, whether it is a direct deposit or a direct payment, starts with the originator/sender’s bank (also known as the originating depository financial institution, ODFI) to the clearing house, and finally, to the recipient/beneficiary’s bank.

Here’s what happens behind the scenes:

The originator (individual/business) begins the ACH transfer at their financial institution, also referred to as the Originating Depository Financial Institution (ODFI).
The financial institution bundles a number of ACH transactions together and enters the entire batch into the ACH Network.
This batch of transactions will then reach an ACH operator, which is either the FedACH (Federal Reserve Bank’s Automated Clearing House) or the Electronic Payments Network (EPN).
The ACH operator sorts the batch and forwards the transactions to the beneficiary’s bank or financial institution, known as the Receiving Depository Financial Institution (RDFI).
Once the RDFI validates the transaction, the funds will be credited to the beneficiary’s receiving account, thus reconciling both accounts and ending the process.

🔑

How long does an ACH Transfer take?

For most financial institutions, there is a cut-off time where the payment will not get processed until the next business day. However, if there are no issues with the transaction, a typical ACH transfer should only take 1 – 2 days to complete.

Bear in mind as well that the ACH transfer process may fail and, consequently, will require a longer period to complete. These issues can be incorrect information format, insufficient funds in the sender’s account, or incorrect payment details.

In response to its tedious process, NACHA introduced the Same Day ACH in 2016, to cater to users who require much speedier transaction times. This transfer method is processed on a per-request basis by the financial institutions. Due to this, the Same Day ACH comes with a slightly higher fee, a $1 million USD per-transaction limit (as of March 2022), and does not support international transactions.

Advantages of ACH Transfers

In comparison with more traditional payment methods, like paper cheques, ACH payments can offer more advantages for businesses of any size, in any industry.

Lower costs – ACH payments have lower transaction costs than most electronic payment options, such as credit cards and debit cards. Not just that, it also has a lower processing fee because it does not need to pass through several intermediaries before reaching its final destination.
Better security – According to a JP Morgan report, cheques are still among the most fraud-susceptible payment methods and businesses should avoid using them for payments. ACH, however, provides much stronger user protection, as it requires validation through a processing centre. This validation — the ACH Validation — keeps a record of a customer’s checking account, including their history of bounced cheques and fraudulent payments.
Convenience – ACH transfers’ capability of automated payments helps ensure a business receives their funds on time and eliminates the hassle of missed payments. It also eases the burden for the senders as it removes the time-consuming manual intervention.
Shorter processing time – Although it isn’t instantaneous, sending and receiving ACH payments is usually quicker than cheque payments. NACHA mandates all ACH credits to settle in one to two business days, and ACH debits to settle in the next business day.

🔑

Limitations of ACH Transfers

Despite its advantages, ACH transfers still have shortcomings and may not be suitable for certain businesses. Here are some potential drawbacks to keep in mind before making an ACH transfer.

Transaction limits – Depending on the financial institution, there is often a limit on ACH transactions. And these can be per-transaction limits, daily limits, weekly limits, or monthly limits. In this instance, the user may be required to make several transactions if the total transfer amount is greater than the imposed limit.
Associated fees – ACH transfers are not completely free for businesses and most banks charge a per-transaction fee for ACH payments. Ergo, if you’re performing multiple transactions (perhaps due to the imposed limit), this fee can add up and put a dent in your bottom line.
Limited usage for international transfers – In its early years, the ACH network only covers the US. However, this network has since expanded to cover international payments, and according to a report by NACHA, the network recorded over $247 billion USD in international transfers. The only caveat is that not all financial institutions offer this service just yet.

How to make an ACH Payment

The exact process may vary from bank to bank, but here is an overview of the process of making an ACH payment:

Step 1: Gather the necessary information

A typical ACH payment will require the documents such as sender’s name, routing/ABA number, account number (or IBAN), account type, and transaction amount.

Step 2: Choose between ACH Debit and ACH Credit

ACH debit requires the originator to establish the transaction with the payee. In this situation, the originator must submit their payment details (similar to the list in Step 1) to the payee.

An ACH credit, on the other hand, is mostly used for payments, such as bill payments or even standing orders. With this type of transfer, the originator authorises their financial institution to send a payment to a payee. The originator’s account details will not be sent to the payee.

Step 3: Executing the ACH Transfer

Before you pull the trigger and execute the transaction, ensure you have:

Specified if the transaction will be a credit or debit
Entered the correct payment amount
Stated the payment date

Bottom line

The advent of ACH transfers has lowered the barriers to making payments. Instead of having to withdraw funds from one account and deposit them into another, this electronic payment system permits users to do it with a few simple clicks. Not just that, it also comes with a lower cost, better security, and a shorter processing time.

However, keep in mind that ACH transfers have a set of limitations, such as transaction limits, associated fees, and limited usage for international transactions. In such cases, users will have to resort to alternatives, such as an instant bank transfer through the RTP Network or wire transfers.

If you want to make global payments while keeping costs low, check out Wallex’s cross-border payment solution, where your recipient does not need a Wallex account to receive payments. But if your recipient is a registered Wallex user, they can receive the funds instantly and for free.