ACH payment: What is it and how does it work?

What is an ACH payment?

An ACH payment is a payment sent via the ACH (Automated Clearing House) network, an electronic network used to send paperless payments between bank accounts in the United States. If you think of payments as the money taken out of your account when you have your monthly bills on autopay - that’s typically done via ACH. Deposits are a category that includes your paycheck coming via direct deposit. 

Established in the 1970s to deal with the growing number of paper checks needing processing, the Automated Clearing House now processes an enormous volume of payments more safely and efficiently than paper checks. According to PaymentsJournal, in 2022, the ACH Network safely processed 30 billion payments valued at over $76 trillion.

Let’s take a closer look at ACH payments and how they work. We’ll also zoom in on some of the ways ACH payments differ from EFT payments and wire transfers.

How do ACH payments work?

When a payer authorizes a payment, the bank submits the details to the ACH network, which routes the transaction to the recipient's bank. The recipient's bank then credits the payee's account while debiting the payer's account—a process known as settlement. 

Perhaps the most well-known example of an ACH transaction is payroll direct deposit. This is a good scenario to explain how the ACH network works since many Americans receive their paychecks that way:

1. Employee enters their bank number into the payroll system.
2. Employer initiates payment several days before payday to ensure payments arrive on time. 
3. ACH payment is batched, processed, and routed to the correct banks.
4. Payment is deposited into the employee's account.

Typically, ACH transfers take 1–3 business days to complete—a process much faster than paper checks. Financial institutions can also choose to have ACH credits processed and delivered within one business day, per guidelines set forth by NACHA. Those same guidelines state that ACH debits must be processed by the next business day. With an increasing need for faster transaction times, most major banks and credit unions are on this system.

Benefits of using the ACH network

If you’re considering the ACH network for business payment processing, there are several benefits to consider. They include:

• Lower processing fees: ACH transactions fees average out at $0.29. Credit card processing costs, on average, 1.3% to 3.5% of the transaction. Do the math. There’s a significant savings potential with using ACH payments.
• Fewer declined transactions: Credit cards get denied and checks bounce. Insufficient funds can happen when using ACH, but it's less common and the bank is on your side when it comes to collecting the payments that are due.
• Convenience: No need to write checks, deposit them, or even run credit cards.
• Convenience for your customers: Autopay by ACH payment is far from a new concept. Most consumers are already doing it for bill paying. Offering it as a payment option for your business is adding a convenience. Your customers will appreciate you for it.

Limitations of the ACH network

There are a few limitations of the ACH network that all businesses should be aware of:

• Transfer limits: There are same-day maximum transfer limits. If your volume is higher than what’s allowed, this could be a problem.
• Cutoff times: Paper check deposits don’t count until the next day if made after 2:00 PM. ACH transactions are no different.
• International transactions: The ACH network is only available inside the United States, so businesses operating internationally will need another option.

How to set up ACH payments for your business

Once you’ve made the decision to start accepting ACH payments for your business, the setup process is simple. If you’re using a payment solution like BILL, you only need to sign in, connect a bank account, and add customers or vendors. The mechanism to request ACH payments is already built into the software. If you’re doing this manually, here are the steps you need to take:

• Set up an ACH merchant account: You’ll need a federal tax ID number for this. You will be asked how long you’ve been in business and what your estimated volume will be.
• Request customer authorization: When done manually, this requires paper or online forms. You can do it with a phone call, but it’s better to have written documentation.
• Set up payment details: You’ll need bank routing and account numbers from each of your customers, along with payment amounts and frequency.
• Submit payment information: You’ll need payment processing software for this, so it’s probably simpler to just let BILL handle the whole process for you.

ACH payments for recurring bills

The ACH network is often used for monthly recurring bill payments. Many vendors prefer this method because the processing cost is lower than credit cards and faster than waiting for paper checks. Examples of the types of bills you may already be paying with ACH payments include:

• Credit card monthly payments
• Utility payments
• Auto loan payments
• Mortgage payments
• Merchandise on monthly payments

Bill payments are usually listed as ACH debits, while payments to your account from another entity, like the US Government or IRS, are classified as ACH credits. The difference is that credits are pushed into an account while debits are pulled out of the account. Hopefully, that alleviates any confusion.

ACH payments involve three other parties in addition to the Automated Clearing House itself. Those three parties are:

• The Originating Depository Financial Institution (ODFI)
• The Receiving Depository Institution (RDFI)
• The National Automated Clearing House Association (NACHA)

The ODFI initiates the transaction and the RDFI receives it and processes it through the Automated Clearing House. NACHA is the governmental agency that oversees and writes the regulations for the ACH. They protect you from fraud and ensure that the network works at optimal speed, so you don’t have to wait weeks for payments to process.

ACH payments vs wire transfers vs EFT payments

There are some important differences between these payment methods that may help you decide which one is best for your situation.

First, the term “EFT payments” is just another way to describe ACH payments, so you can bundle those two together. 

Wire transfers, on the other hand, are significantly different. 

Wire transfers process payments in real time over the Swift Network and can get you your money in a few hours. 

ACH transfers use the Automated Clearing House Network and can take several days to process.

Of course, you pay for that convenience. Anyone who’s ever sent money using Western Union knows that the cost is high, sometimes as much as $60, depending on the amount being sent. It’s a nice option to have if someone needs funds quickly, but it’s too expensive for merchants to use as an everyday payment method. ACH transfers usually cost under $1.

For a more in-depth comparison, check out this guide: ACH transfer vs. wire transfer: The payment choice is clear and the comparison table below:

Are ACH payments right for your business?

Here are some questions that’ll help you decide whether or not ACH payments are right for your business.

Does your business accept recurring payments?

Subscription services and service providers generally fall into this category. 

Customers are able to make their monthly payments with credit cards, but the processing fees for the business can be expensive. ACH transaction fees are more cost effective. The median cost is just $0.29 per transaction.

Are you currently taking paper checks? 

Any business owner or manager who does daily reconciliation can tell you that counting checks at the end of the day is time consuming and inefficient. 

Handwritten checks are sometimes difficult to read and each one needs to be checked for proper date, amount, signature, and contact info. 

Paper checks are an archaic and outdated system. They need to be deposited, and can be stolen or lost in the mail. ACH transactions are faster and more efficient.

Are your customers comfortable with online transactions? 

Most people are the days, but if you have an older customer base you may face some resistance. Making the transition to ACH transactions requires commitment from the business owner. It may take some time for customers to fully embrace it.

ACH rejection codes and reasons

Though rejections and denials are a risk with any payment method (except cash), this might be considered another drawback. There are times when a request for an ACH payment or deposit may be rejected. There are several reasons that could happen. If you experience this, look for one of the following rejection codes on the transaction statement:

• R01: Insufficient Funds: This is most often seen when a customer initiates a payment and doesn’t have enough money in their account to cover it. The customer should contact their financial institution right away if this happens to avoid NSF fees.
• R02: Bank Account Closed: When an account has been closed and the payer doesn’t inform the payee, this rejection code will appear on the payee side. The best course of action is to call the customer and get updated account information.
• R03: Unable to Locate Account: This code is often an error on the payee side. It’s possible you were given incorrect information, but you should check your own work before you jump to conclusions.
• R04: Rejection: When the system kicks back a simple R04 “Reject” response, it means that the bank isn't allowing the sender to withdraw funds from that account. Usually, the bank just needs an originator code to enable ACH withdrawals.

Like checks with insufficient funds (NSF), the bank will charge a fee if your business triggers a rejection code. This may have been caused by an inadvertent error on the data entry side or due to an accounting mistake. Either way, contact your bank right away if you get a rejection code. They might be willing to waive the fee if you act promptly.

ACH payment FAQ

Is the Automated Clearing House secure?

NACHA has a set of rules and regulations that govern the ACH process and determine eligibility for businesses using the network. Among those mandates is the requirement that businesses and third-party processors encrypt banking information with “commercially reasonable” technology. Today, that means 256-bit SSL encryption. Additional security is provided by the payment processor. Together, these requirements make the ACH process very secure.

What’s the difference between an ACH payment and direct deposit?

Direct deposit is simply a type of ACH payment. In fact, direct deposit is perhaps the most common type of ACH payment, seeing how common it is for employees to receive their paycheck via direct deposit.

How long does it take for an ACH payment to go through?

ACH payments may take 3-5 business days to complete. ACH payments are not instantaneous, and are processed in batches throughout the day. Depending on a variety of factors, including the bank doing due diligence to ensure sufficient funds are available, the payment may take a few business days to go through.