Understanding ACH Payments for Better Chargeback Defense

ACH payments have become increasingly popular in recent years due to the convenience they offer for both customers and merchants. However, with the rise in use comes the potential for disputes and chargebacks. As a merchant, it’s important to understand ACH payments and how to defend yourself against chargebacks to keep your business running smoothly.

In the U.S., several regional ACH associations were created in the ‘70s until in 1974 the National Automated Clearinghouse Association (NACHA) was founded. NACHA administers the network, but it does not operate the physical ACH Network. The processing of ACH transactions is handled by the Federal Reserve and The Clearing House.

ACH payment volume has increased steadily over the past decade. Last year, the ACH network processed close to 27 billion electronic payments, totaling $62 trillion. This represented 11 percent year on year growth in the total dollar volume of payments using this method. By way of contrast, there were 40 billion purchase transactions using credit cards in the U.S. in 2019 and $8 trillion in credit card purchase volume in 2020, according to the Nilson Report.

ACH stands for Automated Clearing House, which is a payment processing network that allows for electronic transfers from one bank account to another. ACH payments are commonly used for direct deposit, bill payments, and online purchases.

Two types of payment via ACH exist, credit and debit.

An ACH credit is a type of ACH transfer where funds are pushed into a bank account by the payer. That is, the payer (i.e. the customer) actively chooses to move the funds to be sent to the payee (i.e. the merchant).

An example of this sort of transaction would be when an individual pays a bill through their bank or credit union. This would be processed as an ACH credit.

ACH payments have become increasingly popular in recent years due to their convenience and cost-effectiveness. Unlike traditional paper checks, which can take several days to clear, quick and efficient processing makes them a popular choice for both consumers and businesses.

Another advantage of ACH payments is that they are more secure than traditional paper checks. Because the transactions are processed electronically, there is less risk of fraud or theft. Additionally, ACH payments are subject to strict regulations and guidelines, which help to ensure that they are processed accurately and securely.

Unlike credit card transactions, which can be disputed and charged back by the customer, ACH payments are subject to return or dispute for a limited number of reasons. These reasons include unauthorized transactions, incorrect payment amounts, and transactions processed after the customer has revoked authorization.

ACH payments typically take 2-3 business days to process, and the funds are transferred directly from the customer’s bank account to the merchant’s bank account. This means that merchants can receive payment quickly and efficiently, without having to wait for checks to clear or worry about the security of cash transactions.

One of the benefits of ACH payments is that they typically have lower transaction fees than credit card payments. This can be a significant cost savings for merchants, especially those who process a large volume of transactions.

There are two primary types of financial institutions that operate within the ACH Network, the originating depository financial institution (ODFI) and the receiving depository financial institution (RDFI). ODFIs and RDFIs must adhere to strict regulations that protect and safeguard sensitive banking and client information. Financial institutions will usually be approved to serve as both ODFIs and RDFIs.

The ODFI is the financial institution where the ACH entry is originally placed. The ODFI must ensure that the original entry is accurate and then either debit money from the originating bank account or deposit money into it depending on whether an ACH debit entry or ACH credit entry was submitted.

To submit an ACH transfer request, the transaction originator must provide the following information to the ODFI:

• The name of the financial institution that will be receiving the funds on behalf of the individual
• The type of account that the funds will be deposited into (i.e., checking or savings account)
• The bank’s ABA routing number
• The recipient’s account number
• The name on the receiving bank account

The request will then be pushed through the Clearing House and Federal Reserve and then to the RDFI.

On the other end is the RDFI that receives the ACH entry. The RDFI has 48 hours to complete the request so that a return code can be processed. If a return code is pulled, it means that there was an issue with the ACH entry request. A return code indicates that the ACH payment request cannot be processed. This can be for many reasons, including insufficient funds, wrong payment data entry, or a compromised account.

If an ACH payment is returned, the OFDI will provide the originator with a reject code that explains what happened. The three most common reject codes are:

• R01 Insufficient funds
• R02 Bank account closed.
• R03 No bank account/unable to locate account.

If no return code is pulled, the money is transferred without a hitch and the transaction is settled.

If you receive an ACH return dispute, it’s important to know how to handle it effectively. Here are some common reasons for ACH returns and how to handle them:

Unauthorized transaction: If a customer disputes an ACH payment as unauthorized, you will need to provide proof that the customer authorized the payment. This could include a signed contract or an electronic signature.

Incorrect payment amount: If the customer disputes the payment amount, you will need to provide proof of the agreed-upon amount. This could include an invoice or a payment confirmation email.

Revoked authorization: If the customer revoked authorization for the payment, you will need to provide proof that the revocation was received after the payment was processed. This could include a timeline of events or an email chain.

Fraudulent ACH returns can be especially damaging for merchants, as they often involve stolen identities and large transactions. Here are some red flags to look out for and how to protect your business:

Large, unusual transactions: Be wary of large or unusual transactions, especially if they are from a first-time customer or account.

Repeated returns: If you notice a pattern of returns for similar product or service types, it could be a sign of fraud.

Verify customer information: Always verify customer information, such as their name, address, and phone number, to ensure it matches with the payment information.

In addition to handling ACH disputes effectively and protecting against fraud, there are also proactive measures you can take to minimize your risk of returns:

Clearly communicate policies: Make sure your customers are fully aware of your payment policies and procedures, including any fees associated with returns or cancellations.

Confirm payment information: Always confirm payment information with your customer before processing an ACH payment. This can help prevent errors and unauthorized transactions.

Monitor returns: Keep track of your return rate and watch for any patterns or issues that may require additional attention or investigation.

• Convenience – No more paper invoices and paper checks and time-consuming trips to the bank.
• Lower processing costs – ACH payments typically have the lowest processing fees of any type of payment. Some ACH processors charge a flat rate, which typically ranges from $0.25 to $0.75 per transaction. Others charge a flat percentage fee, ranging from 0.5 percent to 1 percent per transaction. 
• Fewer declines due to expiration – Checking accounts don’t expire like credit and debit cards. That means you’ll experience far fewer declines when processing ACH payments.

• Processing times – ACH payments are processed by in batches at set times throughout the business day. They don’t occur instantly and can take up to three working days to clear. Wire transfers, in contrast, are processed in real time, so money changes hands almost immediately.
• Penalties – Rejected ACH payments can cost your business a penalty fee. If you receive a reject code, it’s important to quickly correct the issue to avoid incurring additional fees in each recurring billing cycle.
• Transfer Limits – There can be daily and monthly caps on how much money you can move that are set by your bank. The Same Day ACH transfer limit is set at a maximum amount of $100,000 by NACHA after it was raised a year ago from $25,000. The network has proposed raising the limit to $1 million for Same Day ACH next year, which would enable companies to make the vast majority of their payments through ACH if they so choose. 
• Cutoff times – After a certain time of day, a transfer won’t be processed until the next day (or Monday, if it’s before a weekend).
• U.S. only – U.S. banks don’t allow ACH transfers to and from international bank accounts. For international transactions you will need to accept credit card or wire transfer.

From a cost perspective, it may make sense to encourage clients to make payments to your business through ACH if they are based in the U.S. However, please note that just like credit cards, ACH payments can be subject to chargebacks. Unlike credit cards though, ACH returns don’t have a representment process for the merchant to present their case. That means you should accept ACH payments only from customers you deem trustworthy.

Now that we’ve gone over the basics of ACH payments and chargeback defense, let’s answer some common questions:

Can customers dispute ACH payments?

Yes, customers can dispute ACH payments for limited reasons, such as unauthorized transactions or incorrect payment amounts. However, ACH payments are not subject to chargebacks in the same way as credit card payments.

Which merchants are most vulnerable to ACH disputes?

Merchants who process high-risk transactions, such as travel or ticket sales, are more vulnerable to ACH disputes. Additionally, merchants who do not have clear payment policies or do not confirm customer information may be at higher risk.

ACH return timeframes vary depending on the reason for the dispute and the processing time of the banks involved. However, most ACH returns are processed within 2-3 business days.

As a merchant, understanding ACH payments and how to defend against disputes and chargebacks is crucial for protecting your business and ensuring smooth operations. By following best practices and strategies for proactive risk mitigation, you can minimize your risk and keep your business running smoothly.