ACH Payments: What They Are and How To Use Them (original) (raw)

An automated clearing house payment is an efficient way for a financial institution to move money instead of using paper checks. If you’ve ever gotten a Venmo payment or received a direct deposit for a paycheck or tax refund, then you’ve received an ACH payment.

In this article, we at the MarketWatch Guides team will explain how these electronic payments work and why they’re increasingly preferred over paper checks and other forms of payment.

Key Takeaways

• ACH payments are electronic funds transfers that are faster and more efficient than paper checks or wire transfers.
• ACH transactions typically settle within one to three banking days.
• Common uses of ACH transactions include payroll for business owners and person-to-person payments through Venmo, PayPal and Zelle.

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What Are ACH Payments?

ACH payments are fast and efficient electronic transfers between bank accounts. They include bank-to-bank transactions, business-to-employee transactions, peer-to-peer transactions and automated bill payments.

An ACH payment comes in the form of either an ACH credit or an ACH debit transaction. ACH credit examples include receiving your paycheck via an electronic funds transfer (as a direct deposit), getting paid via PayPal or receiving government benefits such as Social Security payments or tax refunds.

ACH debits remove money from your bank account to pay someone else. They can be set up as a one-time payment or recurring payments. ACH debits can simplify recurring expenses, allowing you to set up utility bill payments on a certain date each month or replenish a transit pass when the amount dips below a certain threshold.

Financial institutions (including banks and credit unions) and businesses of all sizes benefit from ACH payments because they reduce administrative overhead and the traditional waiting period for paper payments to clear. Electronic payments can also streamline business expenses and tasks such as payroll.

How ACH Payments Work

The automated clearing house network is the payment processing system that handles all ACH payments and debits. Although making an ACH payment is a relatively quick process, there are several steps behind the scenes that facilitate the transaction.

Step 1: The Transaction Is Initiated

For example, say a small business distributes its employee payroll via direct deposit. First, the small business will initiate the transaction by authorizing its bank to pay its employees. The small business’ bank, where its funds are held, is the Originating Depository Financial Institution.

Step 2: The Payment Request is Sent to the ACH Operator

The ODFI sends the payment request to push funds from the business’ account to the ACH operator to be processed and distributed to the employees’ banks. The employees’ banks are the Receiving Depository Financial Institutions.

Step 3: The ACH Operator Sends Payment to Receiving Banks

Then, the ACH operator batches all of the payments from the ODFI together and ensures that each payment goes to the right place. This is done by sending an electronic file to each employee’s bank, indicating that the RDFI is authorized to pull funds into each employee’s account. After receiving the funds, each employee’s bank deposits the funds into the appropriate account. Each employee who’s paid is a receiver.

ACH transactions can take anywhere from a few hours to three business days. The amount of time an ACH payment or debit takes depends on a few factors:

• The time and day of the week the transaction is initiated
• The time zone of the receiving bank
• Whether the transaction was requested to be a same-day ACH payment

There are only two national ACH operators: the Federal Reserve Banks’ FedACH Services and the Electronic Payments Network. Both of them receive, edit, sort, deliver and settle ACH payments. The EPN is operated by the Clearing House Payments Company.

Benefits of ACH Payments

ACH payments are widely used due to their speed, security and cost-effective nature. Unlike paper checks, ACH payments don’t have to be mailed, so there’s no concern about postal delays or the potential for a lost or stolen payment.

Plus, with ACH payments, you don’t need to manually enter each employee’s or vendor’s information for payroll or multiple recurring payments, which can significantly cut down on administrative work.

Lower Processing Fees

ACH payments can also be much less expensive for a vendor to accept than credit card payments. The typical processing fees for credit card payments range from around 1.5% to 3.5% of each transaction. In comparison, ACH processors typically charge much lower fees.

According to the Association for Financial Professionals, the median cost of initiating and receiving an ACH payment for all businesses is 26 cents to 50 cents.

To put this into perspective, a 1,000creditcardpaymentwitha31,000 credit card payment with a 3% processing fee would cost a vendor 1,000creditcardpaymentwitha330, while a 1,000ACHpaymentcouldcostlessthan1,000 ACH payment could cost less than 1,000ACHpaymentcouldcostlessthan1.

Additional Security Measures

Although no payment method is foolproof, ACH transactions are typically more secure than other payment methods.

For instance, ACH transactions require only a single setup with the receiver’s financial information, such as their bank routing number and account number. Checks and wire transfers, however, require the receiver’s financial information each time a payment is made, which exposes that information to more people.

Pros

ACH payments are typically faster than mailed checks.

ACH transactions are typically less expensive to process than other forms of payment, such as credit cards and wire transfers.

ACH payments can be recurring, reducing the amount of labor required for bookkeeping.

Cons

As with any financial transaction, there’s a risk of sensitive financial information being stolen.

Domestic ACH transactions are limited to the U.S. and require U.S. bank accounts.

ACH Payments for Businesses

ACH payments are most commonly used for recurring expenses such as direct deposit payroll for employees and vendor payments. Direct deposit payroll is far more efficient than issuing individual checks, and you can set up automatic ACH payments for vendors to eliminate the risk of paying late or missing a payment.

The ACH Network aggregates all of your company’s payments into a batch, and then the clearing house operator directs that batch to electronically move funds from your company’s bank to the employee’s or vendor’s bank.

Business-to-business ACH transactions, or corporate ACH transactions, operate on the same electronic funds transfer principles through the ACH clearing house. Corporate ACH transactions can be single payments or recurring payments, and they come in two main types:

• Corporate credit or debit
• Corporate trade exchange

The differences between the two types come down to the amount of explanatory information that must accompany the transaction. A corporate transaction that’s coded as a CCD ACH payment needs just one piece of information, called an “addenda,” to relay any related payment information, whereas a CTX ACH payment can have up to 9,999 additional pieces of information.

ACH Payments for Individuals

ACH payments can simplify your financial life. You can set up automatic ACH transfers for your major recurring expenses, such as rent, a mortgage or a credit card bill to ensure you’re never late or miss a payment. ACH transfers also eliminate the hassle of mailing checks or getting money orders.

Also, ACH payments are generally more secure than paper checks. Paper checks can be lost in the mail, stolen or illegally altered. ACH payments are done electronically, which has more controls and checkpoints in place and minimizes the exposure of banking information.

According to the 2024 AFP Payments Fraud and Control Survey, 65% of respondents said they experienced check fraud in 2023, while 20% reported ACH debit fraud. In comparison, in 2022, 63% of respondents reported check fraud and 30% reported ACH debit fraud.

Security Measures in ACH Transactions

Nacha, formerly known as the National Automated Clearinghouse Association, is the governing body of the ACH network. Nacha has developed rules to ensure reliability and safety across all parties involved in ACH transactions. Here are the requirements:

• All protected information, or personal information that isn’t public, must be kept confidential and secure from unauthorized use or anticipated hazards. This extends to Social Security numbers, addresses, bank account information and other other sensitive financial and non-financial information that might be used fraudulently.
• All relevant bank account information used in a transaction must be protected by commercially reasonable encryption technology, and customer information must only be made available to the parties involved in facilitating the transactions.
• Originators must validate the routing numbers of any accounts they intend to pull money from or push money to.
• Originators must use commercially reasonable methods to verify customers’ identities. This could include verifying someone’s Social Security number or their driver’s license or making a test deposit when setting up an ACH account.

Nacha updates its existing rules regularly. Its Rules Enforcement Department works to ensure that all involved parties comply with the standards for ACH transactions. It can also assist with arbitration if two parties have a disagreement about a transaction.

The Bottom Line on ACH Transactions

ACH transactions streamline payments, simplifying tasks such as payroll and automated payments. These quick electronic payments can save time for both senders and recipients since they eliminate the need to go to a bank in person to withdraw money or deposit a check.

Although no payment method is foolproof, an ACH transaction is generally more secure than paper checks and less expensive to process than credit cards and wire transfers, making it an ideal choice for businesses and consumers alike.

FAQ: ACH Payments

An ACH payment is an electronic funds transfer, or EFT, from one bank to another bank. Instead of receiving funds through a check or wire transfer, you’ll receive a direct payment in your bank account at a minimal cost to the sender and no cost to you.

To pay someone via an ACH transfer directly from your bank account, you’ll need the recipient’s routing number and bank account number. Another option for making a personal ACH payment is using a peer-to-peer payment service such as Venmo, PayPal or Zelle, the latter of which may be offered through your bank. Once you make an account with service and connect your bank account, you can pay someone else in just a few steps.

Typically, ACH payments take one to three business days to complete. Same-day ACH payment is also possible, but the fees are slightly higher, and the transaction must be completed before the bank’s cutoff time for same-day ACH processing.

*Data accurate at time of publication