With a variety of options for payment collection, Automated Clearing House transfers, known commonly as ACH payments, are a convenient and secure option for many businesses. ACH payments are particularly handy for those that charge recurring payments (e.g., gyms, schools, etc.) as well as those that accept large sums (e.g., law firms and professional services). Though credit and debit card transactions are ubiquitous in the payment industry, ACH payments accounted for 26.8 billion payments in 2020.
Since ACH payments continue to grow year over year, it’s important for businesses to understand the basics of this kind of transaction, and what happens when ACH transfers are returned.
The Basics of ACH Payments
Before discussing how ACH returns work, it’s important to understand the basics of an ACH payment.
ACH payments are electronic transfers that are regulated by the National Automated Clearing House Association, or NACHA. ACH payments use the bank routing number and account information to transfer funds between banking institutions. These transactions usually process in one to three business days and are often a lower-cost option than credit or debit cards or wire transfers.
Among other things, the ACH network is used for direct deposit, recurring bill payments, large transactions in the professional services industry, business-to-supplier transactions, and more.
Understanding ACH Returns
The vast majority of ACH transactions process without issue, but when a transaction cannot be completed, a return is triggered. To understand ACH returns, it’s important to outline the parties involved and how they interact throughout this process.
The parties involved in an ACH transaction are the originator and the receiver, referred to as the Originating Depository Financial Institution (ODFI) and the Receiving Depository Financial Institution (RDFI).
The ODFI sends an ACH request to the RDFI, where it is either accepted or rejected. If rejected, the receiver sends an ACH return to the originator with a reason code that describes the cause of the issue. All of this is done in conjunction with the ACH operator that processes all of the transactions between the ODFI and the RDFI.
What Causes ACH Returns?
ACH returns (sometimes referred to as ACH rejects) are initiated when the transaction cannot process as intended. Because ACH transactions do not process in real-time like a credit or debit card authorization, they can be returned or rejected after the transaction is assumed complete.
When this happens, an ACH return code explaining the issue is generated, and the RDFI notifies the ODFI with a three-digit return code.
An ACH return shouldn’t necessarily be a cause for worry. There are many reasons a transaction can fail to process; it could be as simple as a mistyped account number or something more complicated, like someone revoking authorization for the transfer.
In any case, you can typically resolve issues by coordinating with your customer or the financial institution involved.
The best way to figure out how to resolve an ACH return is by looking at the code to determine the cause.
What Do the Different ACH Return Codes Mean?
Each ACH return code is structured as an “R”, followed by a two-digit number. Though there are 85 return reason codes for ACH transactions, most businesses will primarily deal with the same handful of return codes. The ten most common return codes are as follows:
- R01: insufficient funds in the transaction account
- R02: bank account closed
- R03: no account or unable to locate account
- R04: invalid account number structure
- R05: unauthorized debit (caused by a consumer using a Corporate SEC Code)
- R06: ODFI requested return
- R07: customer revoked authorization (transaction is disputed by the account holder)
- R08: payment stopped (also known as a stop payment)
- R09: uncollected funds
- R10: originator not known and/or not authorized to Debit Receiver’s Account
Codes R05 and R07 are only used for consumer accounts and can take up to 60 calendar days to resolve. The majority of other return codes take about two banking days to resolve. However, it is important to note that the ODFI and RDFI handle the resolution of ACH returns as governed by NACHA. These codes continue to evolve, and there are different rules for how the ODFI and RDFI must handle the return depending on the return code.
What are SEC Codes?
Standard Entry Class (SEC) codes are a mandatory part of ACH payments and are used to specify the type of transaction. These are critical to understand, as SEC codes are governed by NACHA and are a part of the required file format for ACH payment processing. Without proper SEC code classification, an ACH transaction will result in a return. There are multiple SEC codes, and more than one can be included to describe the transaction.
The most common SEC codes are listed below:
- ACK is the code for ACH Payment Acknowledge and is used to acknowledge a credit payment by the Receiver. This code is usually tied to CCD and CTX codes.
- ARC is the code for Accounts Receivable Conversion for a single debit entry transaction for consumer or non consumer accounts. These are used when a payment is received in the form of a check and the payment is converted to an ACH transaction.
- BOC is the transaction code for Back Office Conversion and is used when payment is made in-person with a check and is then converted and processed as an ACH transaction behind the scenes.
- CCD is the code for Cash Concentration or Disbursement and is a non-consumer transaction facilitated between another business or related subsidiary. This is typically used for cash management purposes.
- CTX is code for Corporate Trade Exchange and is used in business-to-business transactions. This allows a merchant to add addendums to the payment which allows for multiple invoices.
- IAT is the code for International ACH Transaction and is used when debiting consumer or non-consumer accounts located outside of the United States.
- MET is the code for Machine Transfer Entry and is used for debits that are initiated electronically.
- POP is the code for Point of Purchase and is used when converting a check presented in person. These are processed immediately, versus collecting a check and depositing with cash and other checks at a financial institution after the transaction.
- POS is the code for Point of Sale and is a single entry credit or debit transaction for consumer accounts, initiated through an electronic terminal.
- A similar code to this is SHR, or Shared Network Transaction which is a single entry debit transaction initiated electronically at the point of sale.
- PPD is the code for Prearranged Payment and Deposits and can be used for single entry or recurring payments. This code is commonly used for direct deposits and automatic bill pay, for example.
- RCK is the code for Re-presented Check Entry and is used to process a transaction that was previously declined or returned due to insufficient funds.
- TEL is the code for Telephone Initiated Entry and is used when a debit ACH transaction is initiated over the phone.
- TRC and TRX are codes for the Check Truncation Program, which essentially is the process where financial institutions make a digital copy of a check to process the transaction, versus the physical mailing of paper checks.
- WEB is the code for Internet Initiated Entry and is used when debit ACH transactions are initiated and authorized online.
There are many cases where several codes would be used for an ACH payment, so it is important for businesses to understand the codes commonly used in their transactions, and properly classify ACH transactions in order to prevent a return and ensure smooth payment processing.
What Happens if ACH Payments are Returned?
ACH returns are initiated by the RDFI in response to a transaction that does not meet the criteria to process properly.
The ODFI is notified with the three-digit ACH return code as to the reason, and the banking institutions must then work together with the consumer or business to correct the issue.
Let’s say a professional services provider gets an ACH return with the code “R08” — payment stopped. To resolve this, the provider contacts their client to determine why they issued a stop payment, and they discuss the issue. Once they’re on the same page, the client contacts their bank to reverse the stop payment, and the transaction goes through.
While ACH returns happen, just as credit and debit card transactions are declined, there are specific regulations set by NACHA that businesses must adhere to.
To maintain compliance, businesses processing ACH transactions must keep the overall return rate below 15%. Administrative returns, which are return codes R02, R03, and R04 must stay below 3%. Unauthorized returns, classified by codes R05, R07, R10, R29 and R51 must stay below .5%. To calculate the percentage, NACHA looks at the preceding 60 days on a rolling basis.
What is an ACH Return Fee?
Just as there is a transaction processing fee, there are additional fees for ACH returns. These fees vary, but typically cost $2-$5 per return and are typically passed on to the consumer – the same way a bounced check would incur a fee.
Can ACH Returns Be Disputed?
ACH returns can be disputed if the transaction meets specific criteria. The RDFI can request the ODFI to dishonor the return if the transaction was misrouted, was a duplicate entry, included incorrect information, was not returned within a proper time frame as permissible by NACHA, or if there was an unintended credit to the receiver during the reversal process.
Since ACH returns have a turnaround time of 2 banking days for most transactions, dishonored returns must also be resolved in a timely manner. Returns that meet the above criteria must be sent in within 5 banking days from the return settlement date. They can still be contested by the RDFI at this point, in which case the dispute is resolved outside the ACH network.
ACH payments have experienced tremendous growth in the past several years as business is increasingly done virtually and merchants seek less expensive methods to process transactions that also provide convenient solutions to their customers.
Understanding the mechanisms for how a transaction is processed and what to do when payments are rejected is an important step when considering the addition of ACH payment processing to your business.
Stax provides an all-in-one payment processing platform, designed with inclusive payment options (including ACH payments) for your customers. See how we can help you streamline payment processing, improve productivity, and help you build a better business.
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