The Automated Clearing House (ACH) network connects more than 25,000 banks and other financial institutions to allow for the electronic movement of money between accounts across the country. Two types of transactions can occur on the network: ACH credit and ACH debit.
In 2015, nearly 62 percent of transactions processed on the ACH network were ACH debit. ACH debit is also known as direct payment, and its most common use is for recurring billing set up between a customer and a biller, such as a utility company, insurance company, or lender. According to a 2013 study conducted by NACHA, the organization that oversees the ACH network, direct payment was the leading consumer bill payment method, with nearly 50 percent of all bills paid this way. Billers also noted that receiving payments via ACH debit was their number-one preferred method of getting paid because it improves operating efficiencies and saves money. In the case of recurring billing via ACH debit, it also ensures that bills get paid on time.
How ACH debit works
An ACH debit transaction occurs when the originator of a transaction authorizes the recipient to “pull” funds from his or her account. For example, say a customer wants to pay an electric bill via ACH debit. The customer is the originator of the transaction, and his bank is the Originating Financial Depository Institution (ODFI). The customer authorizes his bank, the ODFI, to send money from his account to the recipient’s upon the recipient’s, in this case the electric company’s, request.
The transaction then follows several steps, which occur for every ACH transaction: The electric company’s bank, called the Receiving Financial Depository Institution (RDFI) uses the customer’s routing and account numbers to send a request through a clearing house such as the Federal Reserve to contact the ODFI and transfer the funds. Because the ODFI has already received the authorization to do so from the customer, the funds are then pulled from the customer’s account to the electric company’s on the pre-determined date. If the customer has enabled recurring billing, he has authorized the regular withdrawal of funds from this account, and this process repeats monthly.
How ACH debit differs from other payment methods
ACH debit is similar to ACH credit with one major difference: Instead of "pushing" funds from the originator's account as in ACH credit, the money is "pulled" in a debit transaction. For instance, in the example above of the customer paying his electric bill, he could pay the same bill using ACH credit by initiating the transaction himself. The ODFI would send the necessary information, with the recipient’s bank account information and amount of the transaction, to the clearing house. The clearing house would then process the information and send it to the RDFI, to be deposited in the recipient’s account. The difference between this and ACH debit is that instead of authorizing the recipient to withdraw the funds, the originator is now sending the funds himself. ACH credit transactions are most often used for direct deposit payroll transactions, P2P payments, and one-time bill payments.
An ACH debit transaction is also different from a debit card transaction, although these, too, are similar. Like ACH, a debit card functions largely like a check, withdrawing funds immediately from the payer’s account and transferring them to the payee. However, a debit card transaction relies on a PIN or signature to authorize a transaction, whereas an ACH debit transaction requires a user’s account and routing number or online banking credentials to authorize. What’s more, a debit card transaction relies on an entirely different network. Rather than connect two banks directly through a clearing house, as an ACH debit transaction does, a debit card transaction relies on connections with the card networks and payment processors that in turn communicate with the banks. As a result, accepting payments via debit card is more expensive for merchants than accepting payments via ACH debit, because all the players involved in the process charge interchange and other fees. A debit card transaction can cost around 1 percent of the transaction amount plus a flat transaction fee, depending on merchants’ contracts with their card networks and processors. ACH debit transactions, on the other hand, are free.
Same Day ACH debit
ACH is growing in popularity; in 2015, the network facilitated more than 24 billion transactions—up 5.6 percent from the previous year, and that number continues to grow. In order to keep up with the changing face of the payments landscape, NACHA implemented Same Day ACH in order to ensure faster processing of ACH transactions. Phase 1, which began in September 2016, focuses on ACH credit transactions and makes it possible for ACH transactions to clear the same day they’re initiated. Previously, these transactions took around two to four business days to settle.
Phase 2, which will be implemented in September 2017, focuses on ACH debit. Under this new rule, ODFIs will be able to submit batches of ACH debit transaction requests to the clearing house at two new pre-determined times: 10:30 AM and 2:45 PM. The files submitted by these deadlines will be required to settle by 1:00 PM and 5:00 PM, respectively, local RDFI time. Enabling faster ACH debit processing times is expected to expedite bill payments and decrease late payments due to processing times.
Security considerations of ACH debit
While ACH debit is generally a secure way of making payments, there are a few things to keep in mind when it comes to keeping information safe. Unlike ACH credit, where the user initiates the transaction, ACH debit requires a customer to hand over routing and account numbers to the recipient. Of course, if these sensitive numbers fall into the wrong hands, the effects can be devastating. On the other hand, these numbers must only be provided once, when recurring billing is set up for the first time, rather than exposed every month, as is the case when paying monthly bills by check. Plaid provides a solution to this problem by allowing vendors and billers to offer users the option to authenticate their accounts via their online banking credentials instead of their account and routing numbers. Login credentials are easier for the user to change at will and do not pose as high of a security risk.
Another consideration is that many people who set up recurring billing with ACH debit may not pay attention to their bills as much. Therefore, if the wrong amount is withdrawn or the user falls victim to fraud, it may not get noticed right away. However, ACH debit transactions can be disputed if they were not authorized by the account holder or processed on a different date or for a different amount than authorized. As opposed to credit cards, where transactions can be disputed for a number of reasons, often leading to chargebacks for merchants, these narrow criteria help protect merchants from fraudulent customers when it comes to paying with ACH debit.