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 ( 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.