What is the ACH?

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The automated clearing house, better known by its acronym ACH, is a type of secure payment processing system that connects nearly all of the banks and major financial institutions in the United States.

This system works as a form of central clearing and settlement service for much of the electronic fund transfer, or ETF, transactions that take place across the nation. Created before the general emergence of the World Wide Web and online lending, the ACH electronically linked together participating institutions.

Numerous financial entities transmit and receive ACH entries via ACH operators. These operators include the Federal Reserve, the American Clearing House Association, the Electronic Payments Network and VISA.

How ACH works

The automated clearing house is governed by rules that were put into place by the National Automated Clearing House Association (NACHA). The transfer of funds can be initiated by the payer’s institution or the receiver’s institution. In the case of an automated personal loan payment using ACH, for example, here’s how the process typically works:

  1. Request for money. The lender instructs its bank to send a request for payment from the borrower’s bank.
  2. Paying bank processes request. The borrower’s bank receives the ACH request and deducts the requested amount from the borrower’s savings or checking account. The bank originating the payment is called the ODFI (originating depository financial institution). If the borrower checks his or her online bank account during this process, the borrower will usually see the notation “pending ACH transfer” listed for the amount being withdrawn from the borrower’s bank account. These funds will not be available to the borrower during the processing period.
  3. Receiving bank receives funds. The lender’s bank will be notified by the borrower’s bank that the loan funds have been transferred. However, the lender’s bank will not make these funds immediately available to the lender. The institution receiving the payment transfer is called the RDFI (receiving depository financial institution).
  4. Operator processing. The ACH operator then finalizes the transaction by “clearing” the transfer. The ACH operator can be the Federal Reserve Bank or a private organization.

Businesses and consumers utilize the ACH system because it can provide a lower cost solution than using a credit card, which may charge higher fees. In addition, because the checking or savings account that is used by the payor in an ACH transaction does not have an expiration date, ACH also provides a more convenient way to transfer funds on a long-term basis.

History of ACH

The automated clearing house system was originated in 1972, and became a nationwide service in 1978. The system was created in order to help reduce the use of paper checks, especially those for recurring payments. By setting up recurring ACH payments from customers, creditors can also better ensure that they will receive their payments on time from customers.

In 1980, the ACH system was allowed to directly compete with the Federal Reserve Banks through the passage of the Monetary Control Act.

By the year 2000, more than 4.8 billion payments had been processed by automated clearing houses through the Federal Reserve System.

Types of payments handled through ACH

ACH transactions can encompass both recurring payments as well as one-time payment transactions. There are numerous types of payments that are sent and received through ACH. These include:

  • Payroll direct deposit – Using ACH for payroll direct deposit eliminates the need for costly paper checks. This process also allows for a faster transfer of funds to the recipient’s account. Plus, it ensures employees that funds will be available on their pay date, rather than having to wait for the check to clear.
  • Social Security payments – Likewise, Social Security funds can also be directly deposited into a recipient’s account, allowing the recipient to avoid the physical act of depositing the check each month. In addition to the convenience of immediately available funds, electronic transfers also provides added security as recipients no longer have to worry about physically depositing and withdrawing funds from banks.
  • State and federal tax refunds – Because tax refunds can also be directly deposited, the threat of theft is greatly reduced. In addition, payments are received much more quickly.
  • Insurance premium payments – Setting up ongoing insurance premium payments, as well as other recurring payments such as utility bills and automobile loan payments, can offer convenience for the payor, as well as assurance for the creditor that funds will be received on a regular basis.
  • Internet retail payments – Online shoppers can also easily make payments for purchases that are made on the Internet – without the need to send a paper check or use a credit card.

Perhaps the biggest advantage of using ACH for money transfers is the lower cost involved when compared to using high-fee check cashing, money order and credit card services.

Using ACH is also convenient given that approximately 90% of the U.S. population has a checking account. In addition, ACH also provides an easy method for setting up recurring payments such as monthly payroll or monthly billing.

Standard Entry Class (SEC) designations

When using ACH for payment processing, the process requires that Standard Entry Class, or SEC, code be utilized in the transaction. This code is used for designating how the transaction has been authorized by the originator.

These SEC codes include:

  • ARC – Accounts Receivable Entry
  • CBR – Cross Border Entry
  • CCD – Cash Concentration and Disbursement
  • CIE – Customer Initiated Entry
  • COR – Automated Notification of Change
  • CTX – Corporate Trade Exchange
  • MTE – Machine Transfer Entry
  • PBR – Cross Border Entry
  • POP – Point-of-Purchase Entry
  • POS – Point-of-Sale Entry
  • PPD – Prearranged Payment and Deposit
  • RCK – Re-presented Check Entry
  • TEL – Telephone-Initiated Entry
  • WEB – Internet-Initiated Entry

Alternatives to ACH for electronic fund transfers (EFTs)

The ACH system was built before the mass emergence of the web. As public use of the internet has grown, new alternatives and future competition for the ACH system have emerged. Some of these include:

  • PayPal – PayPal is a large electronic payment and money transfer system. This entity serves as an electronic commerce, or e-commerce, payment facilitator that moves funds between parties.
  • Dwolla FiSync – Dwolla FiSync provides real-time bank transfers in a similar manner as ACH. It allows parties to link with businesses, as well as to transfer funds between friends and family members and those who are affiliated via social networks.
  • Credit card networks – Using a credit card network, a cardholder can request a purchase from a merchant, while the merchant subsequently submits the request to the acquirer. These networks include entities such as VISA and MasterCard. It is important to note that these networks are different from credit card companies such as Citi and Chase.

Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.

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