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What is an Electronic Funds Transfer? - Definition, Process & Benefits

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  • 0:00 Electronic Funds…
  • 0:45 Uses For Electronic…
  • 2:10 Traditional VS. Electronic
  • 3:25 Benefits Of Electronic…
  • 6:10 Lesson Summary
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Lesson Transcript
Instructor: Aaron Hill

Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.

Learn about what electronic funds transfer is and all the ways you may use it in your daily life. Find out how the process differs from the older paper style and some of the many benefits that you can experience by adopting electronic funds transfer.

Electronic Funds Transfer Defined

Can you imagine trying to shop on the Internet and the only way to pay is by sending a check in the mail? How about not being able to use a credit or debit card when you went out to eat or put gas in your car? The way in which we transfer money has advanced tremendously over the last several years. PayPal, online bill pay, and mobile payments are all examples of recent advancements. These changes are referred to as electronic funds transfer, or the electronic transfer of money from one account to another. Electronic funds transfer uses computer systems to move funds without the need for paper documents. Yes, people sometimes still use paper checks, but electronic funds transfer methods are now the preferred way to do business.

Common Uses for Electronic Funds Transfer

Let's look at several ways that you may currently use electronic funds transfer:

Using a credit or debit card - Using this method, money is transferred electronically from your account to the seller's account. This is one of the most widely used forms of payment. In 2010, Visa and MasterCard processed over $5 trillion in transaction volume!

Online bill payment - Often referred by many as online banking, this has become very popular as a quick and easy way to pay monthly bills. More than two out of every three bills are now paid in an electronic form. This has recently further evolved into the ability to pay bills directly from your mobile device or phone.

Direct debit - This is often referred to as electronic checks or monthly auto draft. Individuals can set up a recurring schedule and payment instructions for companies to automatically pull money from their bank account to pay for bills or services. Many people pay their house or car payments this way. The method simply requires sending the institution a voided check with your routing and account number.

Direct deposit -This form of employee payment is now the preferred way to get paid from your employer and is often the only way for some jobs. Your paycheck enters your bank account quicker, and the employer saves hundreds or thousands of dollars in not printing and delivering checks.

Traditional vs. Electronic

Because the electronic funds process is simplified and entirely electronic, the cycle of transferring and paying money is much faster. Let's compare both traditional and electronic processes side by side.

Writing a Paper Check

The store manually deposits the check at their bank, and the bank sends the check to a clearing house , or an establishment where checks and bills are exchanged. The clearing house sends the check to the customer's bank to be posted. This is an older process that contains no electronic money transfer and would usually take at least a week to complete the cycle.

Electronic Funds Transfer Process

When you use your card at a store, money is electronically transferred from your account and then it is simultaneously deposited in the store account. This may involve an automated clearing house or sometimes a central electronic processor, which could add a day to process, but it is still much quicker.

The process for a consumer to set up online bill pay, direct deposit, or direct debit is fairly simple. It usually involves providing data to the financial institutions, including your bank routing and account numbers, vendor account numbers you want to pay and dates of payments. It can usually be done online or by filling out a simple form.

Benefits of Electronic Funds Transfer

There are many benefits to electronic funds transfer. Let's explore them more in detail.

Cheaper - The cost savings are numerous. For example, by using online bill pay every month to pay bills such as water, gas, electricity, and credit card, you could save the postage rate on every bill paid. So if you paid 10 bills a month this way, you are saving almost $5 in postage, plus the costs of checks for the month. Plus, it takes only a few minutes to pay all of your bills online. Writing out checks and delivering them to the post office could take you much more time. So add in the value of your time saved!

Faster - Electronic funds transfer has made buying and selling on the Internet much simpler. Money can be sent between accounts in real time. For example, when you sell something online, you can see when money has been deposited into your account within minutes or seconds of the other person sending it. A paper check could have taken five days.

Safer - People's identity and money are still most easily compromised the old-fashioned way. Anytime you pay manually with a check or send something in the mail, you are introducing additional parties that will be handling your funds. From the post office employees and the person getting the mail at the business you are sending it to, to the accounting department recording and depositing your check, there are several instances for theft or fraud to occur. With technology encryption, verification, and passwords, electronic funds transfer has become a safer way to do business.

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