How does an ACH payment work?

The speed and low cost of ACH makes it an attractive alternative to other payment options

Most people have made or received an ACH payment, which bypasses card networks and sends money directly from one bank account to another. Companies often use ACH payment processes to pay employees. Developed as an alternative to checks, ACH payment is now becoming one of the default options for paying and getting paid online. Some of the most common ways people use ACH payment is to make payments for online bills, mortgages and loans, and to pay employees via payroll direct deposit.

ACH payment offers a number of benefits over other payment methods. It’s cheaper and stickier, so it should come as no surprise that an increasing number of businesses and individuals opt for ACH payments.

What are the benefits of ACH payment?

ACH payment has several major benefits over other payment options such as credit cards, debit cards, checks, and cash. In particular:

  • ACH payment is cheaper and has lower transaction fees. Because many ACH processors charge a flat fee per transaction, this makes an ACH payment much cheaper than one made by credit card, which can charge a fee between 2 and 3 percent. Other ACH processors may charge a percentage per ACH payment, but these are also lower: often less than 1 percent. Credit card fees also rack up because many intermediaries are involved, all of which take a cut of the fee.

  • ACH payment is ideal for recurring billing. One of the biggest benefits of ACH is that ACH payments can be set up for recurring billing. That’s because recurring billing depends on connections to the bank account—which, for better or worse, doesn’t change. This creates stickiness. In other words, employers can send out payroll payments automatically, without having to devote manpower to manually writing checks or even manually entering payment information. Consumers can also set up recurring or automatic billing to pay monthly bills via ACH payment, which leads to fewer missed payments overall. Recurring ACH payments account for nearly half of all ACH payments on the network, and the number of recurring payments grew by more than 4 percent from 2013 to 2014.

  • ACH payment is faster and more convenient. An ACH payment traditionally takes up to three days to process, which is slow compared to the real-time nature of cards. But there are ways to streamline the process. For example, Plaid helps onboard people for ACH payment by eliminating microdeposits, which add a lot of time spent waiting around for those penny deposits to post. Similarly, although the use cases are currently narrow, with this year’s introduction of Same Day ACH processing, an ACH payment can settle on the same day it is made. An ACH payment also settles much faster than a check, which can take a day to clear, but which also requires additional time and effort to write, mail, and deposit it electronically or in person. By contrast, an ACH payment can be initiated instantaneously online. According to the Federal Reserve, ACH payments have grown significantly over the last decade, largely replacing checks, and Internet-enabled ACH payments have made a particularly large contribution.

  • ACH payments are better alternatives to checks. ACH payments require account authorization before the payments can be made. This is done to ensure that a bank account exists and that it belongs to the person claiming it. Verifying accounts’ existence helps minimize errors, thereby decreasing the number of returned and fraudulent transactions. Moreover, some ACH payments—such as those facilitated by Plaid—don’t require providing any sensitive account information such as routing and account numbers or credit card numbers.

How does an ACH payment work?

It’s clear that more and more businesses and consumers are on board with making ACH payments. But how exactly does money get from one bank account to another when an ACH payment is made? There are several steps and several key players involved:

  • An ACH payment Originator can be an individual, a company, or another entity, and the Originator can initiate direct deposit or direct payment transactions. For example, the Originator can initiate payroll payments, Social Security benefits, mortgage payments, bill payments, P2P transactions, and other ACH payments.

  • To begin the transaction, the Originator sends ACH payment files to its partner bank, which is known as the Originating Depository Financial Institution, or ODFI. These files contain routing and bank account numbers necessary for the ACH payment to occur.

  • The ODFI hangs onto all ACH requests that come in throughout the day. At predetermined times, the ODFI electronically transmits all ACH requests in batches to an ACH Operator, such as the Federal Reserve or The Clearing House. (These batches account for some of the delay in clearing ACH payments. NACHA, which oversees the ACH network, implemented Same Day ACH processing in September 2016, which introduces additional times throughout the day that batches can be sent to the ACH Operator.)

  • The ACH Operator then sends the information to each recipient’s associated bank, which is known as the Receiving Depository Financial Institution, or RDFI.

  • The RDFI then deposits the indicated amount of money for the settled ACH payment in the recipient’s bank account.

A broad fintech ecosystem supports ACH payments

Accepting ACH payments used to be a difficult process, especially for small businesses who had no connection to an ODFI (not all banks are ODFIs). However, third-party apps have made this process much simpler, now facilitating support for ACH payments. Companies like Stripe connect merchants and businesses with ODFIs, and apps like Venmo and PayPal allow individuals to send ACH payments to each other and pay for goods and services hassle-free. Plaid also facilitates ACH payments by allowing users to connect to other merchant apps securely and easily.

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