What Is ACH and How Does It Work?

ACH is an acronym that represents Automated Clearing House — a fitting name for the U.S.-based clearinghouse network through which funds can be moved directly from one bank account to another. Most people have used the ACH system at some point in their lives, whether they knew it or not; this may include using a direct deposit of your paycheck, paying a bill over the Internet, or setting up automatic payments on a loan.

The ACH system is very different than credit card systems (there are multiple payment card networks) and wire transfers (these are typically faster but more expensive). The ACH system was designed as a low-cost, bank-to-bank electronic funds transfer system for everyday transactions and recurring payments.

In this guide, we will explain what ACH is, how it works, how long it takes to clear, and the costs. We will also cover what to do if something goes wrong.

What the ACH network does

ACH uses a very structured method to process large amounts of money transfers. This means, rather than processing each money transfer individually at the time of the transaction, they group money transfers by category and run those groups at specific points during the day.

Nacha (National Automated Clearing House Association), the entity responsible for overseeing the ACH system, has established rules and guidelines that all financial institutions (banks and credit unions) and payment service providers (e.g., Bill.com) must follow when initiating and accepting ACH payments. Those rules pertain to such things as authorization, window for initiating a transaction, and handling of returned or disputed payments.

There are two major ACH operators in the U.S.: The Federal Reserve and EPN (Electronic Payments Network). It is typically through either of these two entities that your bank or credit union establishes its relationship with, allowing you to both initiate and accept ACH transactions on their behalf.

ACH vs other payment methods

ACH is best described as “reliable and low cost,” not “instant.”

Unlike paper checks, ACH transactions are typically processed more quickly and are easier to manage. Checks may sit in the mail, be copied (or worse), or simply get lost in transit. As an electronic payment method, there is less “friction,” and therefore fewer “moving parts.”

Compared with credit cards, ACH is generally less expensive for merchants, as they pay a percentage of the sale amount in credit card processing fees rather than a fixed fee for an ACH transaction. In addition, many consumers view ACH transactions as very low-priced or even free (depending on the type of transaction) when using their online banking systems.

Compared with wire transfers, ACH is typically slower but much less costly. Wire transfers are most commonly used when the timely receipt of funds is more important than cost, such as with larger, more time-sensitive transactions.

ACH credits vs ACH debits

In addition to the transaction type (credit/debit), another aspect that can confuse people is that the term “ACH” is used to describe both credit and debit transactions. The key point, however, is the direction of the movement of the money; thus, the distinction between an ACH credit and an ACH debit is based on whether the funds are moving into or out of your account.

For example, an ACH credit represents money entering your account. Direct deposit of wages from your employer, a federal tax refund deposited into your checking/savings account, are examples of ACH credits.

On the other hand, an ACH debit represents money being withdrawn from your account. When you authorize a lender/creditor to make automatic withdrawals from your bank account using your routing number, your account number, etc., you have authorized them to perform ACH debits on your behalf. Common examples of ACH debits include mortgage payments, utility bills, insurance premiums, membership fees, subscription charges, and loan payments.

Same Day ACH

Same Day ACH transfers typically take 1 business day to process. Same Day ACH is an option that can speed up certain transfers so they clear on the same business day, provided the payment is submitted before the cut-off time, and your bank supports it.

Additional fees apply to Same Day ACH compared to standard ACH; however, the fee charged will vary by bank or provider. Many people use Same Day ACH for emergency-type situations such as making late payments, making urgent vendor payments, or correcting payroll errors.

How ACH processing works

When moving funds via ACH, the process involves three parties. The first party is the sending bank, also referred to as the ODFI (Originating Depository Financial Institution); the second party is the receiving bank, also referred to as the RDFI (Receiving Depository Financial Institution); and the third party is the ACH operator.

You do not have to recall these terms; however, you may find them mentioned within bank support documentation or within notices related to ACH transactions.

Here’s what usually happens:

1. Payments are made from one source to another. For example, you receive a paycheck, a company pulls an autopay on a utility bill, or you move funds to another bank account.
2. Your bank compiles your payment(s) into “batches” and sends these to an Automated Clearing House (“ACH”) operator.
3. The ACH operator reviews all of the payment batches sent by each participating bank, then directs the appropriate payment batch to the correct receiving bank.
4. Once a payment reaches a receiving bank, that bank will post the transaction to the recipient’s bank account.
5. Any final clearing and settlement between the banks involved in the transactions occurs through the ACH system.

Although the use of batching and scheduling allows somewhat predictable processing times, they do not support instantaneous transactions.

Timing and what can slow ACH down

Most ACH (Automated Clearing House) transfers are processed within 1-3 business days. However, some could process faster than this, while others might take a little longer due to additional review.

Timing is everything when it comes to ACH transactions. The two timing factors are cut-off times and business days. When you initiate an ACH transaction after your bank’s cut-off time, it will not begin moving until the next business day. In addition, weekends and federally recognized holidays will suspend the regular ACH processing cycle.

First-time transactions may take a little longer as well. Sometimes, banks may require additional verification for first-time users connecting a new bank account or sending funds to a new recipient. Also, banks may put certain transactions through “fraud” review. This may cause delays in posting.

ACH costs: what to expect

ACH typically costs a merchant less to process than card processing, and often costs less than wire transfer; however, the actual cost will depend on the bank and account type sending the funds, as well as the payment method (e.g., online banking).

Many consumer banks have specific ACH transactions offered at little or no charge when using their online bill pay and bank-to-bank transfer services. The ACH fees charged to businesses can vary depending on their ACH provider and the volume of transactions they process. Merchants who elect to use the same-day ACH service may incur additional charges.

To determine the true cost of an ACH transaction, review your bank’s fee schedule or your payment provider’s pricing page.

ACH and loan payments

ACH can affect the lending process in two common ways. Lenders may fund via ACH to the borrower; this is why funding may take a business day or two, even after a lender approves a loan. Additionally, ACH is often used as a payment method for monthly loans via auto-pay.

There are a couple of habits that will help you avoid issues when making a loan payment via ACH. Making your loan payment one to two days before the due date will help you avoid cutoffs or weekend delays. Having a small cushion in your payment account will help you avoid returned payments. If you do have to switch banks, it is more important than you realize to update your ACH auto-pay information early.

A returned ACH payment may incur additional fees. The return fee charged by your bank is typically different from the return fee charged by the lender or biller (depending on your agreement). This is why you should treat your ACH auto-pay as a habit you need to actively manage, rather than “set and forget.”

Common ACH problems and how to fix them

The majority of ACH issues occur when an account lacks sufficient funds. When a debit attempt is made against an account with insufficient funds, the debit may be returned. In many cases, it will be better to call the biller if you think this could happen, rather than waiting until the debit returns through.

Delays are also relatively common. Many late payments are simply delayed because they were submitted past a cut-off date or on the day of a weekend or holiday. The best way to avoid delays is by submitting payments earlier. If same-day processing is required, check with your bank to determine if Same Day ACH is available for that type of transaction.

The last of the three major concerns surrounding ACH is unauthorized debits. If you see an unauthorized debit, contact your bank immediately. All major banks have established procedures for reporting ACH errors and unauthorized transactions. Timing is very important.

Summary

ACH is among the most prominent methods for transferring funds throughout the U.S. banking system. Many employers use ACH to process employee paychecks, businesses use it to make bill payments, subscription service companies use it to process their recurring charges, and lenders use it to collect loan payments from customers.

While ACH can be an inexpensive way to transfer funds, the nature of this method is based on a business day schedule that has a specific time frame for when all transactions are processed and cleared. Understanding your bank’s cutoff times and enabling account alert notifications can help minimize or eliminate ACH issues.