How Does Ach Payment Processing Work

The letters “ACH” stand for “automated clearing house” and are commonly used in the banking and financial industries to describe a specific type of transaction. Simply put, when you use an ACH-type transaction to move money, you are sending it from one bank to another bank. The reason millions of people use them every day is because ACH transfers are super-secure, highly convenient, and very fast. ACH is by far the most common way for both individuals and government agencies to move money from one place to another quickly, inexpensively, and securely.

In essence, ACH payments are the primary way for banks to transfer money between each other. It’s important to understand that all funds transferred via ACH systems moves only from bank to bank. Individuals and businesses play no direct role in the transfer process except by virtue of being account holders in the particular banks making the transfers.

If you’re wondering exactly how this style of money-sending operates, consider that you’ve almost certainly been using the ACH system and its style of money transport for a long time without even knowing it. For instance, anyone who has paid a bill online or received a direct deposit paycheck has taken part in the ACH network. Here are just a few of the many ways in which people and businesses utilize the system:

  • Direct deposits from an employer or government agency, like the IRS for a tax refund
  • Online bill payment
  • Deposits into IRA and similar kinds of retirement accounts
  • Automated deposits into college savings accounts
  • Entrepreneurs who get payments or send them to vendors or other businesses or individuals
  • Transferring money to someone’s personal account for any reason

It’s noteworthy that in a typical year, ACH transactions total about 25 billion. The massive popularity of ACH transfers is primarily due to how inexpensive they are and how simple the entire process is.

ACH Transfers: What are They?

An ACH transaction has three distinct characteristics:

  • It must go through the NACHA, the National Automated Clearing House Association
  • It must only move funds from one bank to another bank
  • It must be processed electronically, in batches
  • It must take place during one of the three transfer times on a given business day
  • It must be either a direct payment or a direct deposit

Keep in mind that banks use all sorts of other funds transfer systems. ACH just happens to be the prevalent one. But, for a given transaction to be processed via the ACH network, it must meet all the requirements listed above. Nearly all ACH transfers are free for both the sender and receiver, take place quickly, and are far simpler than using plastic, a check or a standard bank-style debit card.

The Difference Between Direct Payments and Direct Deposits

Because ACH transfers are of only two kinds, it’s essential to understand the difference between direct deposits and direct payments.

If you, as an individual, receive money via ACH from the government or from a business, and the funds are deposited straight into your bank account, then the type of transfer is called a “direct deposit.” You’ve probably received paychecks and IRS tax refunds this way, but there are other kinds of direct deposits, including:

  • Reimbursements from your employer for expenses you incurred on the job
  • Federal benefit payments like Social Security
  • Payments of annuities from insurance companies
  • Payments of interest from banks, governments, or brokerage firms
  • Refunds from companies for products you return

The key difference is that a direct deposit goes into your account because it’s coming from somewhere else and is payable to you personally.

Direct payments are the exact opposite. They are used when you send funds to a government, company, bank, brokerage firm, or to another individual’s bank account. If you owe money to the IRS, for example, and send a payment to settle your account, that’s a direct payment. The way the ACH record-keeping system is set up, whenever you send or receive funds, you’ll see a notation about the amount, who the sender or receiver is, and the exact time the transaction took place. For example, if you pay a utility bill via ACH from your primary checking account at bank XYZ, your account will show the following data after you make the payment: “ACH payment from account 123456789 to City Utility Company. Amount $100. Transaction time: 14:32:07.” That’s just an example with fictitious amounts and a random time, but most ACH notations on your bank account with show all that information whether the funds represent a direct deposit or a direct payment.

Why Do So Many People Use the ACH System?

When something is as popular and widespread as the ACH funds-transfer method, there must be some very good reasons. In this case, all you need to do is look at how the transfers work to understand the benefits of ACH payment processing.

The following benefits of ACH are among the many reasons that billions of transaction take place within the system every business day, every year:

  • Convenience:
    Consumers never have to write checks, send money orders, or pay over the phone when they use an ACH transfer. That’s because the money moves directly and seamlessly from the sender’s bank to the recipient’s bank. Thus, there’s no check-writing, no stamps, no envelopes, no trips to the post office to send anything.
  • Cost: In most cases, banks don’t charge anything at all, or charge a minimal fee, to process an ACH payment. Unlike other forms of money transfer, notably money orders, cashier’s checks, and wire transfers, ACH is a super low-cost way to get money from one place to another.
  • Security: Because funds are not ever leaving the banking network, the security level of ACH transfers is extremely high. That’s why, for example, the IRS and Social Security Administration use the network. This arrangement avoids threats of hackers and anyone who might try to intercept the funds.
  • Speed: Though the transfers do not take place instantaneously, ACH payments typically are completed within 24 hours. Sometimes, if there is a holiday or business day that interrupts the transfer, it might be a few days from start to finish. The reason: ACH operates only on official “business days,” and not on weekends or holidays. Some people cite this limitation as the one and only disadvantage of ACH transfers, but note that it only applies to parties who need rapid transfer of funds to meet a deadline, like a mortgage payment due date or car payment.

Some Negatives

In addition to the timing issues noted above, namely that the ACH system only works on business days, there are a few other minor disadvantages of the processing system. For example, some banks impose limits on how much you can send in a single ACH transaction. Also, there can be limits on the number of ACH transactions you can execute per month. For the most part, however, those disadvantages don’t interfere with the needs of the vast majority of consumers, who use the ACH payment processing system about 65 million times every day.