What is ACH and why does it matter?
Posted on: 14 May 2020
Chances are, if you’re reading this you’ve used ACH at some point in your life. Direct Deposit, Social Security deposits, IRS tax refunds, and other familiar payments use the ACH system to get from one bank to another.
We at Fig use ACH to deposit loans into someone’s account, and to set up automatic payments on their loan. Despite how common ACH is, many of us remain confused about how ACH works and what advantages and disadvantages it has over other forms of payment, like debit cards, credit cards, paper checks, and wire transfers.
In this piece, we’ll break down how businesses like Fig use ACH to process payments and save you money. We’ll also share the pros and cons of using ACH where available, and how to protect your bank account when using ACH.
- ACH is a way for banks to send money electronically to each other
- Companies like to use ACH for direct credits and direct debits because it saves time and money
- ACH payments can take longer to clear than other payment forms, but have several advantages
What is ACH?
ACH stands for Automated Clearing House. A clearing house is a financial institution that acts as the middleman between two member banks to process payments. An automated clearing house just uses computers to automate all the payments, rather than using a physical employee to verify each payment. ACH allows businesses to pull and submit large batches of payments on an automated basis. Most businesses, including Fig, like to use ACH because it costs less to operate than debit or credit card processing and, because payment is automated, lowers the risk of customers not paying because they forgot to make a payment.
How does ACH work?
The National Automated Clearing House Association, or NACHA, has two pretty good infographics to explain direct deposit (direct credit) and direct payment. We’ll break down direct payments, but direct deposits work pretty much the same way, except instead of pulling a payment, money gets deposited. The following steps take place for every ACH payment:
- The company trying to pull payment needs to have prior authorization to pull the payment. This typically takes the form of a signed document containing your routing and account numbers.
- The company submits a payment file to its bank or payment processor. Most companies will send all the ACH files for their business for that business day once, or perhaps several times, during the business day at predetermined times.
- The bank or payment processor sends the transactions to the ACH, who sorts through them and routes them to the appropriate banks.
- The customer’s bank receives the payment request and, if the customer’s checking account has enough money, sends the funds to the company.
As you can see, ACH payments involve more steps than you might imagine when you just see the line item in your checking account. Because of all the parties involved, many of whom are banks, ACH debits can take quite a while. Unlike debit card transactions, which typically take 1-2 business days to clear, ACH transactions can take up to 5 business days to settle completely.
What’s the difference between same-day and next-day ACH?
The clearing times for ACH debits and ACH credits differ because of NACHA rules. ACH credits, where the party making the ACH request wishes to send money (for example, direct deposit of payroll, loan funds, IRS refunds, etc.) typically clear a day after the request is sent, but they can clear faster if the party making the deposit chooses same-day ACH credit. This carries an additional fee, and does not necessarily mean the funds will be available that same day, as Abacus explains.
Fig, for example, uses next-day ACH to send loan funds to our borrowers. We send all the funding requests to our payment processor at 4 p.m. CT, and most of our borrowers get the money in their checking accounts the following morning. Next-day ACH is reliable, affordable, and secure, which is why most Americans get paid via direct deposit.
ACH debits do not, and by design cannot, have such quick clearing times. NACHA requires that the bank pulling funds give the bank losing funds a two-day window before settling the ACH debit. This automatically adds 2 days to the clearing time, so even if the company pulling your payment via ACH uses same-day ACH, the quickest turnaround time for the ACH debit will be 3 days.
Pros and Cons of ACH
Like any other financial tool, ACH payments have their pros and cons. Some of these pros and cons are very similar, and will either be a pro or a con depending on your needs and personality.
- Automatic ACH debits rarely carry a processing fee, unlike debit and credit cards, for bills
- You can turn on automatic debits and forget about paying your bills on time
- Because it pulls directly from your bank account, you don’t need to worry about whipping out your card or updating expired payment methods
- If you don’t have enough money in your account when the ACH debit hits, you can incur costly NSF fees
- ACH payments take longer to clear than other payment methods
- ACH payments lock for processing before they’re actually due, meaning you have less time to change your mind about a payment
We at Fig recommend using ACH wherever possible because the savings can add up over time. For example, let’s say your monthly rent is $1000. Your building’s management company accepts ACH payments, and, for a 3% processing fee, credit and debit cards. If you pay via ACH, your monthly payment stays at $1000, and you never have to worry about your card not going through. If you choose to pay via debit card, you’ll pay an extra $30 every month, for an additional $360 a year that you could have spent on new AirPods or a plane ticket somewhere (when traveling was still allowed, sigh).
Also, people who have their bills set to autopay can avoid costly late fees that happen when one naturally forgets to pay their bill on time, because they simply have too much going on!
Refunds, Stop Payments, and other ACH troubles
Because of the longer clearing time, getting your ACH transaction refunded can take a minute. You need to wait for the original debit to clear completely before the company that debited the money can send the refund, which then takes another day or two to go through the whole ACH process.
Given this lag time, and our earlier mention that ACH debits have a built-in two-day waiting period, you might be tempted to request a stop payment from your bank on a bill payment. In an emergency, stop payments may come in handy. If, for example, a company wants to pull $300 from your bank account, and you don’t have the money to cover that bill, you could be looking at a $35 dollar NSF fee. Banks do not offer stop payments for free, however, and they can really damage your bank account and your relationship with the company requesting the payment.
Every once in a while, ACH payments fail for reasons other than stop payments or insufficient funds. Usually, the company trying to pull the payment will happily explain why the payment failed and offer alternatives.
So there you have it folks! More than you ever thought you needed to know about ACH payments. We hope you enjoyed this dive into ACH payments, and would love to hear from you on how you like to use ACH in your life. As always, we’re available for questions and comments at email@example.com, Facebook, Instagram,and Twitter.