Ultimate guide to Automated Clearing House (ACH) payments
From salaries and mortgages to credit transfers and direct deposits, ACH payments are used to complete countless transactions every single day, all over the world. Since its first use in 1968, the ACH or Automated Clearing House Payment method has served as the go-to for a majority of low-value domestic payments that take place between participating financial institutions.
The Automated Clearing House is a financial network based out of the United States of America. It is used as a means of electronically transferring funds of low value from one financial institution to another, typically within the same country, i.e. for domestic transfers only. The ACH payment method commonly referred to as ‘direct payments’, can be used to transfer funds without the need for any wire transfers, credit card networks, paper checks, or cash.
Each country has its own system for making ACH transactions. For example, in India National Automated Clearing House (NACH) and National Electronic Funds Transfer (NEFT) are used whereas in Europe a pan-European Automated Clearing House for the Single Euro Payments Area, STEP2, is used.
ACH transfers work via a fully automatic, electronic system. For ACH transfers to work all you need to do is provide your checking account and bank routing numbers and authorize your recipient to draw money from your account. This can be done quite easily online or by filling out the necessary paperwork with your payment service provider or bank.
ACH gives a great deal of control because every time a transaction occurs you will have to give permission. Transfers made via ACH usually take anywhere between one to four days to reflect in your account. There are two main categories that ACH payments fall under:
It is used to send funds directly to a receiving account and are initiated by the payer of these funds. For example, paying salaries to your employees.
It is used to request funds and are initiated by the recipient of these funds. For example, auto-collection of recurring payments.
ACH debit is the most popular type of ACH transfer, it is called so because ACH debit transfers are initiated by the receiver or payee. Because these transfers involve a receiver “pulling” funds from the payer it is also known as a “pull” transaction. Examples include consumer payments such as insurance premiums, utility bills, mortgage loans, and other types of bills.
ACH credit is the type of transaction that is initiated by the payer instead of the payee. Contrary to ACH debit, ACH credit is called a “push” transaction because it involves “pushing” funds from one account to another. The most commonly found examples of ACH credit transactions are vendor payments direct deposits, retail payments, and employee salary payments or payroll.
Wire transfers use a network administered by banks and transfer service agencies around the world to transfer funds electronically, across the globe. These transfers typically require information from the party initiating the transfer, such as the receiver's name and account number.
They are also carried out between a sending and receiving financial institution. Wire transfers are all settled entirely electronically, i.e. there is no actual physical exchange of cash involved in the process.
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ACH transfers are used to make low-value domestic fund transfers whereas wire transfers are used to send relatively large sums of money across borders.
Wire transfers are usually faster than ACH transfers. ACH processing can take anywhere between one to four days to reflect on your account whereas wire transfers are reflected on the same business day as the transfer is made.
ACH payment systems have a daily limit on the number of funds that can be transferred per day, some banks also have a per-transaction limit. Wire transfers also have limits but they are usually higher than ACH transfer limits.
Wire transfers are permanent and are impossible to reverse. Money can be withdrawn from an account as soon as funds are deposited via wire transfer. ACH, on other hand, does allow reversals. In case of any fraud or errors, you can submit a reversal request to your bank. Criteria for reversal, however, may differ from bank to bank.
ACH transfers are considerably more secure than wire transfers. They are overseen and controlled by the National Automated Clearing House Association (NACHA). Wire transfers, on the other hand, offer little protection themselves; the Consumer Financial Protection Bureau (CFPB), however, does offer some protection against fraud.
ACH transfers are typically available to be received free of cost, however, 1% of the transaction amount is charged as a processing fee by banks. Other potential charges may also be accrued, e.g. reversal or chargeback fees, return fees, and so on. Wire transfers, on the other hand, are chargeable for both the recipient as well as the sender of the funds; the fees accrued may vary from bank to bank.
The first step in making an Automated Clearing House Payment involves initiation of the payment by an originator. The originator could be a bank, company, or individual. Both ACH debit and credit transfers have to be started this way.
Next, the entry has to be submitted by the ODFI. ODFI is the payment processor or financial institution of choice of the originator of the payment.
After submitting the entries, batches of these entries have to be sent to an ACH operator (e.g. Reserve Banks or Electronic Payments Network (EPN)) by the ODFI or Originating Depository Financial Institution.
These batches of entries then have to be sorted into categories of deposits or payments by the ACH operator.
Once the entries have been sorted, the ACH operator has to then transfer these entries onto the respective Receiving Depository Financial Institutions (RDFI).
The recipient’s bank also has to ensure the presence of sufficient funding in the ODFI in case the ACH payment is a credit transfer and involves the removal of funds.
Finally, once all the aforementioned steps are successfully completed, the RDFI will debit or credit the receiving account depending on whether the transaction is a deposit or a payment.
Unlike a checkbook, ACH transactions are very easy to track. Given that the transaction is directly and constantly linked with a bank data is much easier to sync. Therefore, you can get accurate updates on the status of your fund transfer.
ACH transactions are governed by controlling authorities like the NACHA and are therefore typically very safe. All your data is stored safely by banks and the risk of paper documents being misused is non-existent. Moreover, you can always have your transaction reversed in case of fraud or errors.
ACH is far more convenient than the payment methods it replaced - paper checks. Paper checks are infamous for being inconvenient, error-prone, and fraud susceptible. In comparison, ACH payments are easy to make and secure.
Automated Clearing House payments are quite cheap when compared with other forms of payment. While receiving funds via ACH is free of cost, other potential charges can be incurred; for example reversal or chargeback fees, return fees, etc.
ACH payments are better for retention purposes because, unlike credit and debit cards, checking accounts do not expire. Your records stay with you for far longer than they would with a credit or debit card.
Instead of a global regulatory authority, the ACH process is regulated by country-specific regulatory bodies, for example, the Bulk Electronic Clearing System (BECS) in Australia or the National Automated Clearing House Association (NACHA) in the US. This makes ACH payments highly reliable, entries are processed in batches and these regulatory bodies ensure discrepancies are kept at a minimum for each batch processed.
Before you can decide whether your business needs to use Automated Clearing House Payment services, you need to ask yourself a few questions:
- Is your business dealing with recurring payments?
- Will your credit-card using customers be willing to use ACH instead?
- Are you receiving funds or making a lot of payments using paper checks?
- Are you paid via credit card by a significant portion of your customer base?
- Is making online payments via credit card a pain point for your customer base?
- Are your credit card fees higher than what you might have to pay for ACH processing?
- Does your business fall under the ‘high-risk business’ category and is, therefore, not eligible to use credit or debit cards?
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