ACH Payment Processing 101 for E-Commerce & Online Businesses

75.1 million. That’s the total number of Same Day ACH payments that were made in 2017.

December 2017 alone hit about 15.2 million transactions, which is a whopping 51% increase compared to November’s record.

Financial institutions, businesses, and consumers are reaping the benefits of Same Day ACH. Same Day ACH is now a reality for payroll, bill payment, business-to-business (B2B) payments, account transfers, and many other applications

How do ACH payments work? What does this mean to you, if you’ve customers in the US? And what should you do, if you want to join the “Network”?

This post aims to tackle all that and more.

Here’s a quick list of links to the various topics covered, to help you navigate the post:

  • What is Automated Clearing House (ACH) and how does it work?
  • Why does ACH process transactions in batches? Or, how is ACH different from a wire transfer?
  • What are the benefits of ACH payments for customers?
  • What are the benefits of ACH payments for online businesses?
  • How to accept ACH debit payments?
  • What are ACH payment reject codes?
  • How to verify a customer’s bank account?

What is Automated Clearing House (ACH) and how does it work?

To cut the long story short, the Automatic Clearing House does just that – it’s a central house that automatically processes and clears bank-to-bank transactions in the United States, in batches.

(If you’re satisfied with that explanation, feel free to jump to the next section. If you’re a sucker for jargons and/or want to dive into the nitty-gritties, then the rest of this section is for you.)

For an ACH transaction to go through (in fact, any transaction for that matter), you’ll need two primary participants – the one who initiates a transaction (aka the Originator) and the one who receives it (aka the Receiver).

Correspondingly, their respective banks will be called as the Originating Depository Financial Institution (ODFI) and the Receiving Depository Financial Institution (RDFI).

Now here’s the tricky part, the customer isn’t always the Originator and the business isn’t always the Receiver. And that’s because there are two types of ACH transactions:

  • ACH“Pull” transactions or ACH debits or direct debits – where the payee (eg., the business) pulls the funds from the payer’s (or the customer’s) bank account. In this case, the payer authorizes the payee to pull a specific amount of money, either once or on a regular basis, from the payer’s bank account (this authorization is called a “mandate” in banking lingo). And so the payee initiates the transaction(s), making her the Originator.
  • ACH “Push” transactions or ACH credits or direct deposits – where the payer (the customer) pushes the funds to the payer’s (business’s) bank account. This makes the payer the Originator and vice versa.

So what happens where does ACH come into this picture?

When an Originator initiates a transaction using the ACH Network, the ODFI makes the corresponding ACH entry. It then debits or credits the Originator’s account (depending on the type of entry), collects the various entries from all its customers, and passes them on, in batches, to an ACH operator (the central clearing facility), at predefined intervals (between the closing of a business day and the opening of the next one).

(In the case of a direct debit transaction, the ODFI credits the payee’s account with the said amount, without checking whether the payer’s account has sufficient funds or even exists in the first place. In other words, the banks operate on the ACH web of trust, and assume a certain amount of risk because of that.)

There are two ACH operators (The Federal Reserve or The Clearing House), one of which receive the ACH entries from the ODFI, sort them, and send it across to the RDFI.

The RDFI, in turn, accordingly debit or credits the Receiver’s account.

According to the National Automated Clearing House Association (NACHA), the organization that governs the ACH Network, a credit transaction takes about 1-2 business days to get settled, while a debit transaction takes one business day.

This might spark the question:

Why does ACH process transactions in batches? Or, how is ACH different from a wire transfer?

Let’s say that three banks A, B, and C belong to the ACH Network.

10 customers send $20 each from bank A to bank B. From bank B, 2 customers send $100 each to bank A and 1 customer sends $500 to bank C. Finally, 1 customer from bank C sends $100 to bank A and $300 to bank B.

In the case of a wire transfer, each of these transactions will be handled by the banks individually and every time, they’ll have to make entries to their account books to record the corresponding changes.

ACH operators, however, work in batches, as we know.

If we consolidate the above transactions, we can see that: Bank B has to transfer $200 to bank C. Bank C has to transfer $100 to bank A. And banks A and B don’t have to transfer any funds to each other, as their transactions cancel each other out.

In a wire-transfer world, this would account for about 15 transactions, which, thanks to batch processing, have now been reduced to just two transactions.

While a wire transfer is ideal for you when time is of the essence, ACH is a much better option for non-mission-critical and recurring payments.

Another key difference between wire transfers and ACH payments is that once initiated, the former cannot be canceled/disputed.

On the other hand, ACH transfers can be disputed if:

  • The transaction wasn’t authorized by the payee
  • The transaction was processed earlier than the agreed upon time period
  • The transaction involved the wrong amount

Summing it up,

What are the benefits of ACH payments for customers?

  • It’s a set-and-forget method. In ACH debits, you don’t have to keep going back to update your credit/debit card details. Once the mandate has been set, money will be automatically debited from your bank account on a regular basis. All you have to do is ensure that your bank account has sufficient balance consistently. And, oh, you don’t have to keep an eye on your payment deadlines either.
  • It’s secure. Thanks to the Direct Debit guarantee, you can rest assured that you’re protected in events of payment errors (you get a ‘no-questions-asked refund within 8 weeks after the money has been debited, and you can demand a chargeback for up to 13 months post the settlement of funds). You will also be notified in advance if the merchant modifies the date or amount, and can also cancel a mandate anytime.
  • It’s cost-effective. You’ll be charged anywhere around $10 to $30 by banks to send a wire transfer within the US and above $40 for international transactions while paying via ACH is usually free, banks may charge a very meager fee for bank-to-bank transfers.

And customers aren’t the only ones who reap benefits from ACH.

What are the benefits of ACH payments for online businesses?

  • It minimizes the scope of payment failures (it’s only cards that expire). Every year, about $40 billion is lost because ofonline transactions getting blocked for unwarranted red flags. And it inadvertently leads to a negative customer experience. And around 31% of them blame the merchant when their credit card is declined (head here for a massive resource of credit card processing facts, statistics, and trends).
  • It’s easy on the pocket. While third-party ACH processors will charge flat rates of anywhere $1 or 1% per transaction. Comparing credit card payments, where it typically costs about 3% + 20p per transaction (in addition to a monthly fee) for a merchant account, ACH payments are far more economical.
  • It offers more control. In ACH debit transactions, your ACH processor will ensure that the pre-defined funds automatically land in your account on the pre-defined date (in the absence of any disputes). You can set recurring as well as one-off payments and manage all of them in one place.
  • It improves transaction efficiency. Thanks to NACHA’s rollout of the new Same Day ACH (the final phase of which will be implemented on March 16, 2018), ACH transactions will be processed on the same day, thus making it all the more convenient. (Note: Transactions above $25000 and international transfers aren’t eligible for Same Day ACH. A few banks might charge an additional fee to process ACH payments the same day. To qualify for Same Day ACH debits, you should also pay attention to the preset cutoff times.)

How to accept ACH debit payments as an online business?

In order to accept payments via ACH debit from your customers, you’ll need to work with a third-party ACH processor.

Now, why do you need the assistance of a processor in the first place? Why can’t you directly interact with banks?

In the ACH system, the requestor is authenticated, and the request isn’t. In other words, the ACH system operates based on the fact that it inherently trusts that the requestors (aka the ACH processors) are legitimate. So enabling an unknown individual to act as a requestor will pave way for instant and substantial fraud activities, where they can effectively pull funds from another bank account with no action from the corresponding account owner’s side.

Which is why passing the buck to a third-party processor is not only an easier option but also a more secure option for the entire ACH Network:

Payment gateways/merchant account providers:

  • Forte
  • USA ePay
  • BluePay

Standalone ACH payment processors:

  • Dwolla
  • Bonsai
  • ACH Payments

Hybrid payment service providers:

  • Stripe (+ Plaid)
  • Braintree
  • Quickbooks (Intuit)

Standalone ACH processors have a much smaller processing fee compared to their counterparts and are faster at processing transactions. However, these processors have a limited ecosystem in terms of offering alternative payment methods. They also have a closed-loop system, where both parties must have an account in order to make an ACH transfer.

Payment gateways and hybrid payment service providers, on the other hand, charge a high processing fee. Having said that, they also enable you to accept payments via multiple alternative methods, offer a whole host of solid integrations, and are easily scalable with your business.

Before you go ahead and join hands with the ACH Network, here are a few additional things that you need to keep in mind:

1. ACH payment reject codes:

In ACH debit transactions, the RDFI (the customer’s bank) might decline a transaction under certain conditions and send an error message back to the ACH Network, with a reject code specifying the reason behind the decline. Here are the five most common reject codes:

  • R01 – when the customer’s account has insufficient funds.
  • R02 – when the customer’s (previously active) account is now closed.
  • R03 – when the customer’s bank account number or the name associated with the account doesn’t match with the bank’s records, or when the specified bank account doesn’t exist.
  • R04 – when the account number isn’t valid or doesn’t contain the correct number of digits.
  • R20 – when the customer’s account for which transactions are either prohibited or limited.

Apart from these reasons, a bank can also decline a payment if the amount is higher than the pre-defined transaction limit set by the corresponding bank for ACH payments.

2. Verifying customer’s bank account:

You can avoid a majority of such declines, by just verifying your customer’s bank accounts and ensuring that they have sufficient funds. NACHA recommends the following ways to do it:

  • Micro-deposits – making small test deposits to the customer’s bank account
  • Check verification – a system that checks the existing national database of account numbers of originators/receivers
  • Pre-notification entry – making a zero-dollar transaction to the specified account
  • Debit card number authorization
  • Account verification

3. Offering multiple payment methods:

Even though ACH is one of the fastest growing payment methods in the US, credit card payments are still the most popular option, with the highest growth rate of 10.2%. Usage of digital wallets like PayPal, Google Pay, and Apple Pay is also on the rise, specifically among millennials.

What more?

About 73% online consumers believe that the payment typeaccepted by a business affect their decision to buy from that business.

So it goes without saying, that in the current state of affairs, it’s imperative that you make friends with multiple alternative payment methods.

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