ACH processing 101: All you need to process ACH payments

Understand how ACH processing works and explore risk management techniques to streamline ACH processing in the modern payment landscape

September 20, 2023

Tom Sullivan Pic
Tom Sullivan

Tom is a fintech industry writer who creates whitepapers and articles for Plaid. His work has been featured in publications like Forbes, Fortune, and Inc. He's passionate about the freedom that the union between financial services and technology can create.

Despite the emergence of real-time payment rails, Automated Clearing House (ACH) payment processing still stands as a cornerstone of the financial industry. From direct deposits to online investment app funding, ACH enables fast, seamless transfers of funds in a way that is both familiar and secure. 

According to Nacha, the organization responsible for setting rules and standards for ACH payments, the ACH network processed a staggering 30 billion payments worth $76.7 trillion in 2022, an increase of 5.6% over the previous year. The continued growth of ACH payments highlights the trust both businesses and consumers have in this payment method.

This article explores the inner workings of ACH processing, shedding light on how payment processing works, strategies for streamlining the process, and the pivotal role ACH payments play in shaping the future of payments.

What is ACH processing?

ACH is a payment rail for processing bank-to-bank payments. It’s commonly used for recurring bill payments, peer-to-peer money transfers through apps like PayPal and Venmo, and direct deposit payroll. ACH processing refers to the steps required to move money from one bank account to another. 

ACH payment processing makes the most sense for frequently repeating transactions, such as mortgage or rent payments, funding a trading or brokerage account, or merchants that let customers pay with an app to earn rewards. 

Increasingly, ACH is being looked at for other use cases, such as retail and ecommerce purchases. For merchants, ACH fees are much lower than card payment fees. The more volume a merchant can process via ACH, the more money they can save. In retail and ecommerce, ACH payments are usually processed in a merchant’s app, such as the SmartPay Rewards app that offers bank payments for gas station customers at the pump. 

Consumers appreciate that ACH payments only have to be set up once. For example, utility bill payers using ACH only need to authorize their bank account once, and then they can automatically pay their bills via ACH for the foreseeable future, even if the amount changes. The same flexibility could apply to ecommerce and other use cases as well. 

ACH usage has increased dramatically over the past two decades—largely replacing paper checks. 

ACH payment processing value has increased several multiples since 2000, while check value has nearly halved.

What are expected ACH processing times?

ACH settlement times vary from hours to days, depending on when the payment batches are sent, whether ACH return codes are initiated, and whether or not a payment was sent as same-day ACH, which requires additional fees. Processing times and settlement times from individual banks may also impact how long the payment takes to process.

Processing times are cut-offs established between an ODFI (Originating Depository Financial Institution) and an Originator, while settlement times refer to when the receiver's account is debited/credited. These can vary by institution and can impact when the payment is finalized. 

When an ACH payment is initiated, the transaction is batched and sent to an ODFI for processing. The ODFI then submits the transactions to the ACH Operator. There are two ACH Operators in the ACH network, the Federal Reserve and The Clearing House. The ACH Operators have cut-off times for processing, and a bank’s cut-off deadline may be earlier than the ACH Operator’s cut-off since the bank has to deliver the payment instructions to the Operator before the Operator’s deadline. 

Failing to meet the cut-off times established between you and the ODFI (or between you and your payment processor) could result in the payment being submitted the following day. For example, a same-day ACH payment sent after your applicable deadline for same-day processing will settle the next business day.

Other ACH operators' cutoff times vary. ACH processors or banks may have even earlier cutoff times.

In the past, longer processing times were one of the main drawbacks of ACH payments. However, that has changed with the rise of same-day ACH, which allows ACH payments to settle to the recipient’s bank account on the same day that they were initiated by the Originator.  

The ideal state of ACH payment processing in the US

The ACH landscape continues to grow in the US and around the world. Nacha is committed to making changes to improve the security and speed of ACH payments by increasing same-day payment limits and improving fraud detection standards.  

Looking forward, ACH is likely to improve and become more accessible to consumers and businesses, similar to how SEPA works in Europe. Improvements such as same-day ACH, along with the rising popularity of ACH payments, are likely to make it easier for consumers to use ACH in a variety of places, including online shopping, bill payments, and peer-to-peer payments. 

How does ACH payment processing work?

While ACH is simply moving money from one bank account to another, the actual payment process is a bit more complex than many users may realize. Here's an overview of how ACH payment processing works: 

  • Payment is initiated: A person, bank, government agency, or another entity, authorizes the transfer from one bank account to the other. Depending on whether the ACH payment is a credit or debit, the initiator may initiate a "push" (send money from their account) or a "pull" (draw money into their account.) 

  • ODFI collects information + sends it to the ACH operator: The Originating Depository Financial Institution (ODFI) gathers information about the transaction and the originator, including routing number, account number, name, and other identifying information. 

  • ACH operator verifies + sends file to RDFI: The ACH operator (either the Federal Reserve or The Clearing House) verifies information and sends the file to the Receiving Depository Financial Institution (RDFI), which credits or debits the payment from their customer's accounts. 

  • Funds clear: The payment settles and is deposited into the receiving account. 

  • Return (if there is a return code): Funds can settle before a return comes in, as ACH returns can take up to 60 days to process. If this happens, then the transaction will be reversed, which is why it’s important to hold reserves (more on this below).

A Modern Guide to ACH

How to add ACH to your platform and reduce losses and risks

Where can ACH processing be used?

In the past, ACH processing was primarily used to replace check processing, as it was faster, more secure, and required less time and resources than traditional checks. However, as ACH expands, new use cases are arising. These include: 

  • Ecommerce: Consumers now have the option to securely link their bank accounts to ecommerce platforms, facilitating seamless purchases without the need for a credit or debit card. This makes online shopping easier for consumers and allows businesses to expand their customer base. 

  • Account-to-Account: A2A transfers allow consumers to move money between their own accounts or to fund investment or other types of accounts. Using ACH simplifies the process, saving time and reducing the need for physical transactions. 

  • Buy-now-pay later: The rise of BNPL has redefined consumer financing by allowing consumers to break up large purchases over time. Using ACH facilitates automated installment payments, ensuring a smooth repayment process.  

  • New account funding: ACH is an easy way for customers to fund new accounts. For example, users opening a new investment account with Robinhood can use ACH to transfer money from their bank account and start trading. 

  • Vendor payments and refunds: Companies can easily manage vendor payments with ACH, ensuring timely disbursement of funds while reducing the resources needed to manage paper invoices and checks. When refunds are necessary, ACH enables a swift transfer of funds, fostering stronger vendor relationships. 

Three essentials for streamlined ACH processing

ACH payments offer a secure solution that adapts to the evolving needs of consumers and businesses. As the payment landscape continues to change, streamlining the ACH payment process is crucial to preserving these benefits. There are three steps businesses can take to streamline ACH processing. 

1. Navigating cut-off times

ACH processing times are established between the Originator and the ODFI (or the Originator’s payment processor) and processing generally occurs three and six times per day, depending on the relationship between the two and whether the payment is same-day or next-day ACH. Payments sent after these cut-off times will be processed on the following business day. 

This means, for example, if you send a payment to be processed after the cut-off time on Friday, the payment will not be processed until Monday of the following week. Different banks and payment processors may also have different cutoff times, which can impact when payments settle. 

Tyler Nappy, Product Manager at Plaid shares, "It’s imperative to know your payment provider’s cut-off times for same-day and next-day ACH so you can appropriately route to the rail that will help you meet the expected date for settlement of funds."

For example, if a payment gets sent at 5 pm ET, you’ve already passed the cut-off time for same-day ACH. In that case, it makes more sense to use next-day ACH for a lower price point, as it will settle at 8:30 am ET on the next business day. For a payment that came in at 4 pm ET, you can route it to same-day ACH and expect same-day settlement as long as you meet your bank or processor’s cut-off time. 

Knowing these times and routing appropriately can save you money on processing costs and prevent delays since you know when payment needs to get submitted. 

2. Communicate hold times and use tools to reduce them  

Hold times are used to make sure funds actually settle and are not clawed back due to an ACH return before they are sent to the receiving account. For example, if a new crypto trading user sends funds to their account, these funds might be held for 3-5 days to ensure there isn’t a return. The crypto platform could hold funds past the time when returns would be expected to be seen, which ensures the payment is accurate and funds are available. This can increase the length of time before the user has access to the funds. 

Although this delay is less ideal for customers, it's a simple and effective method to manage payment risk. Communicating this step with customers can alleviate frustration and ensure customers know when to expect funds to deposit. 

However, there is a solution to reducing ACH hold times for low-risk transactions. Using Plaid Signal, businesses can leverage Plaid’s machine learning risk engine to instantly generate a risk score based on 1,000+ risk factors such as Plaid connection history, account usage, and past ACH events. It’s likely that around 90% of transactions will be flagged as ‘low-risk’. For these low-risk transactions, companies that, for example, accept ACH transfers to fund new trading or bank accounts, can safely release funds instantly for use and only apply holds to customers that pose some level of risk.

3. Use reserves to mitigate risk 

Reserves are a common payment industry practice where payment processors hold either a small percentage of all processed payments or a lump sum of cash in a reserve account to cover chargebacks. 

There are two ways reserves are held:

  • Rolling reserves, which is the percentage hold method described above. For example, if a customer buys sunglasses for $10, a payment processor can hold on to 20% for 60 days, and then send the cash to the business. 

  • Static reserves, which is a lump sum of money that doesn’t change over time. This pool of money is held as collateral. 

This allows the processor to hold a small percentage of the overall payments to ensure funds are present in case of ACH returns—while still sending some of the payment immediately. This practice helps mitigate their credit risk and can effectively decrease hold times (the time funds collected are held before being released to the merchant) since there are always some funds available to cover returns before they are settled (a process that can take up to 60 days). 

→ Watch the video below to see how investment company Public uses fast and efficient ACH processing for funding new customer accounts.

How can Plaid help with ACH payment processing? 

As ACH usage increases, companies are continually looking for ways to improve security and reduce risk while streamlining user experience. Plaid Transfer is a single integration that authenticates users, facilitates the processing of ACH transactions, and completes transfers. It's a multi-rail solution that allows users to move funds between accounts using both same-day and standard ACH payments alongside instant payment rails like RTP (Real-Time Payments) and FedNow. 

Additionally, Plaid Signal reduces the need for holds and unlocks an instant ACH experience for low-risk transactions using dynamic payment flows that analyze risk and reduce the risk of returns and fraud. Together, these solutions pave the way for faster, more secure ACH processing. 

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