Aug 23, 2016 Allen Taylor
A Look at the Automated Clearing House for Lenders
Alternative lenders do not have to be relegated to a dark corner of the financial industry just because of the connotations associated with the word “alternative.” Rather, lenders of all stripes can take advantage of some of the legacy systems that have been in place for years. One of those systems is the Automated Clearing House, or ACH.
ACH has, since 1974, provided a way for financial institutions to deliver and receive payments electronically in the U.S. The system is governed by the National Automated Clearing House Association (NACHA), a non-governmental organization with two missions. NACHA’s first mission is to oversee the ACH process, which consists of three components: 1) operating rules, 2) enforcement and risk management, and 3) ACH network development; the second mission is to serve as an industry trade association.
How ACH Works for the Benefit of Lenders
ACH allows lenders a way to receive payments quicker and more efficiently. Before electronic payment systems, payments were made by check, money order, or other types of paper transactions, including cash. With the advent of credit cards, payment and money transfers could be made more directly, more quickly, and more efficiently. Types of transactions that can be made through ACH include credit card payments, debit card transactions, payroll direct deposits, government benefits, bill payments, online banking payments, money transfers, person-to-person (P2P) transactions, business-to-business payments, e-commerce, charitable donations, loan repayments, and more.
The process begins with an originator. It can be an individual, a business, government agency, a non-profit organization, or any legal entity. The originator electronically enters a direct deposit or payment transaction into the network using a routing number similar to those used for check processing. Each transaction is received by an Originating Depository Financial Institution (ODFI).
ODFIs must register with NACHA and follow all NACHA rules to remain in good standing. Once transactions have been received by various originators, each ODFI transmits those payment transactions to an ACH Operator in batches at predetermined intervals. Currently, there are only two ACH Operators, The Federal Reserve, or FedACH, and Electronic Payments Network (EPN), also known as The Clearing House. These two institutions serve as clearing houses for all ACH transactions.
The ACH Operator then sends each transaction to the Receiving Depository Financial Institution (RDFI). The RDFI debits or credits the payment receiver’s account accordingly. According to NACHA rules, credit transactions settle within two business days while debit transactions settle within one business day. NACH has even modified its rules to allow for same-day processing.
As a lending institution, you can have your clients set up a loan account and use ACH to receive loan repayments automatically by withdrawal or through a manual system where the debtor makes periodic payments to you through ACH processing. Through this system, you’ll receive your payments more quickly without risk of paper checks bouncing or taking days or weeks to arrive in the mail before you can cash them. The system is also less expensive than check processing since multiple transactions can be processed simultaneously through electronic means.
How Lenders Can Use ACH for Payment Processing
When it comes to ACH processing, lenders can use electronic payments both for borrower repayment and for sending approved loan monies to borrowers. Before you underwrite new loans, however, make sure you verify borrower bank accounts and perform some due diligence on borrowers who want to use ACH for sending and receiving money.
ACH transaction fees vary from one financial institution to another. Typically, they are either a percentage of the transaction or a flat fee. However, some entities allow free payment transfers under certain conditions. For instance, PayPal allows its users to withdraw from their accounts and send money directly to their own banks at no charge. ACH can be used for such transactions. If your lending institution wants to use free payment transfers as a selling point to entice borrowers into doing business with you, you can use ACH.
Another reason to use ACH is for account verification (http://www.achworks.com/index.php/en/products/ach-tools/check-verification). Once you receive a borrower’s application with their bank account information, you can send a real-time verification check electronically to that financial institution or use a bank account verification tool like IBV or databases to verify the account exists. This can save you a lot of time and expense in collections if you approve a loan and find out later the borrower has no bank account.
Even with ACH transfers, there is always a risk that a borrower’s loan repayments will return unprocessed. You cannot predict whether an individual has the necessary funds to make a payment. Therefore, a certain amount of risk is involved. You can diminish that risk by collecting transaction history on a potential borrower and underwriting a loan based on what you find. If a borrower has a high number of ACH transactions that have not processed due to insufficient funds, then you can adjust their payback terms or deny the application. Microbilt has a risk verification service you can use to make those judgments.
As mentioned before, if you wish to set up automatic debits for borrowers where loan repayments are made through ACH at pre-established intervals, then you can approve loans based on a pre-arranged electronic repayment schedule.
In recent years, NACHA has made more accommodations for money transfers and payments outside of the U.S. However, there are some tricky rules and language involved with these processes. In terms of ACH, there is no official ACH process for foreign transactions—that is, financial transactions that take place between entities where neither party is in the U.S. That doesn’t mean money transfers can’t take place, but NACHA does not have the authority to oversee or regulate such transactions.
Where NACHA has made headway is in transfers and payments between entities where one party to the transaction is in the U.S. This process requires a Gateway. The Gateway is the financial institution or ACH Operator that processes electronic transactions into or out of the U.S. to or from other countries.
Because of the heightened awareness and sensitivity to international drug and human trafficking, terrorism, financial crime syndicates, tax evasion, offshoring, and other illegal activities, the Office of Foreign Assets Control (OFAC) has worked with NACHA to see that the latter includes in its policies rules that ensure ACH transactions do not run afoul of U.S. law. Therefore, this should be a concern for lenders who loan money to foreign entities and individuals or who are considering payment processing across borders.
One positive for lenders is that ACH transactions involving residents of U.S. military installations, embassies, and other U.S. real estate assets in foreign countries are considered domestic transactions and therefore do not need to follow NACHA International ACH Transactions (IAT) rules.
What is the Dispute Process for ACH Transactions?
Lending institutions can go to great lengths to minimize risk, perform due diligence on borrowers, risk verify bank accounts, and check transaction history only to be faced with disputes from borrowers who claim that an ACH transaction was unauthorized. You might even face a situation where a loan you process through ACH was sent to the wrong bank account, unauthorized due to some type of fraud, or simply processed inaccurately. NACHA does have a dispute process.
Regarding disputes, there is good news and bad news. The good news is if you want to dispute a transaction, NACHA rules are in your favor. If a borrower disputes a transaction, NACHA rules are in the borrower’s favor. That doesn’t mean that all disputes are valid and the disputer automatically gets a free ride. It does mean that disputes are an honor to protect the consumer’s interest.
According to NACHA rules, an RDFI must honor a stop payment. RDFIs are in no position to make judgments concerning valid or invalid transactions. A transaction made is a transaction authorized, and that includes disputes. It also includes automatic debits. If you set up an automatic loan repayment schedule by ACH and the borrower disputes that, then those transactions will not take place. You still have recourse under the law to pursue repayment of the loan through other means, and that includes reporting the borrower to the appropriate credit agencies. So, while the benefit of the doubt is given to the disputer in ACH transactions, the law is still on the side of the part with the burden of proof. Keep in mind that once a transaction is out of the ACH system, then NACHA is no longer involved.
In other words, the ACH dispute resolution process can work for lenders or against lenders depending on which side of the dispute they are sitting on. Keep your attorney in your back pocket.
A Disruptive Alternative to ACH
Disruption in the financial industry is beset by one constant reality – intermediaries are no longer necessary. Peer-to-peer (P2P) networks have impacted almost every corner of the financial world, from real estate transactions to banking. Investors can manage their own portfolios, borrowers can turn to the crowd, travelers can exchange currency electronically, and friends and family can send money direct from one bank account to another through their smartphones. This disruption has hit the lending industry just as well.
Venmo is a mobile app that allows one party to send money to another party without involving multiple intermediaries. Transfers use the ACH system and therefore are subject to NACHA rules, however, Venmo account holders are not required to receive the money you send them. Practically speaking, even if you authorize a loan and you send borrowed money to a Venmo account holder, if the Venmo account holder does not authorize receipt of that money, it hasn’t been borrowed. This is another layer of protection, both for the lender and the borrower.
Another benefit to using Venmo is that a Venmo account must be tied to a bank account. During the loan application process, you can have potential borrowers set up a Venmo account and make it a precondition to transfer money through the app. All transactions are free as long as money is funded through a bank account or money is transferred from a Venmo account balance.
clearXchange is another P2P money transfer app that can be used for borrowing and lending money. The benefit to using clearXchange is that it is owned by fraud prevention and risk management company Early Warning and used by the nation’s largest banks. Network banks include Capital One, Bank of America, and Wells Fargo. It is also web-based, which means that borrowers do not need to use their smartphones to conduct transactions.
Such technology succeeds because developers have placed a high priority on security and data encryption technology. Lenders and borrower can be confident that transactions are secure and payments made quickly and safely.
The best way to stay current in your lending practices is to utilize the technology that makes payments and money transfers easy and more affordable. ACH wins on both points. The future of lending and borrower repayment is electronic, and it’s only going to get better.