THE WAY PEOPLE SEND AND RECEIVE MONEY IS CHANGING.

Consumers and businesses are moving toward technologically advanced payment practices that better align with their evolving wants and needs. While the industry has been hearing a lot over the past few years about modern payment rails, it’s important for title and settlement services professionals to understand which payment methods are appropriate for real estate transactions.

Payment Rails

Until the second half of the 20th century, the check collection system was the only widespread payment system. Wire transfers were relatively rare and governed almost entirely by private contract and custom. Today, things look drastically different. Payment rails are the underlying infrastructure and systems that facilitate the transfer of funds between individuals, businesses and financial institutions. They enable the secure and efficient movement of money, both domestically and internationally, and are important components of the global financial ecosystem.

Payment rails have many names, depending on the context and the specific payment system in question. Additional terms used to describe payment rails include:

• Payment networks
• Payment systems
• Settlement systems
• Clearing systems
• Money transfer systems

There are two basic models for transferring money between bank accounts: a “credit” transfer and a “debit” transfer, according to Michael O’Neal, vice president of corporate underwriting at First American Title Insurance Co. Wire transfers—such as Fedwire and Clearing House Interbank Payments System (CHIPS)—as well as the Real Time Payment System (RTP) and FedNow are credit transfers. Meanwhile, the Automated Clearing House (ACH) network is a credit or debit transfer.

Wire Transfers

The term doesn’t have a precise legal meaning, but Fedwire and CHIPS are the two agreed upon “wire transfer” systems. Every day, Fedwire on average handles more than $4 trillion in payments while nearly $2 trillion is moved via CHIPS. Fedwire operates between more than 5,000 U.S. banks that have master accounts at one of the 12 regional Federal Reserve Banks. CHIPS is largely limited to the domestic branches of foreign banks and primarily handles cross-border payments.

“In real estate transactions, we are almost always sending wires via Fedwire, although CHIPS may be used in some commercial transactions involving international investors or lenders,” O’Neal said.

Both methods are governed by Article 4A of the Uniform Commercial Code.

The magical moment in a wire transfer is “acceptance” of the funds by a beneficiary’s bank.

“The concept of acceptance under Article 4A has a somewhat counterintuitive meaning that is not the same as other areas of the law, since it can happen without knowledge or intent,” O’Neal said. “When a beneficiary bank places wired funds in its customer’s account, or gives notice that funds are available, Article 4A invalidates any attempt by the bank to make that payment provisional and therefore revocable.”

Additionally, the person who sent the wire has no right to claw it back except in very limited situations, such as a payment that was wired twice.

The payment finality of wire transfers has some downsides, including wire fraud and error in the payment process.

“If money is stolen or wired in error, it may be out the door and difficult or impossible to get back,” O’Neal said. “In addition, there are significant timing and control issues related to wires.”

Wires can take up to two days to complete. There’s no statutory duty for a receiving bank to act on a payment order. Also, an originating or intermediary bank may delay or refuse to process a payment because they want to avoid “daylight overdrafts.”

“If a bank has received more outgoing wire requests than it has in its Federal Reserve master account, it may put wires in a queue before processing outgoing payments,” O’Neal said. “From a title company standpoint—how are we or our customers supposed to know this is happening?”

Real-time Payments

A “real-time” or “instant” payment is like a wire transfer but with several key differences. Like a wire, a real-time payment operates as a real-time gross settlement system. That is, each payment is handled one by one between participating banks by individual debits and credits to their Federal Reserve master accounts.

However, unlike a wire, where the processing time can stretch for hours or even days, in a real-time payment the entire transfer happens nearly instantaneously, according to Mickey Vandenberg, vice president of escrow operations for Stewart Title Co.

“There are no wire cutoff times or windows in which payments must be made,” she said. “These systems are intended to be used both by businesses but also for consumer, peer-to-peer payments.”

Complex federal laws—and potentially state laws, depending on the issue—govern FedNow. The RTP system is governed by a complex interplay of federal and state as well. Most of the rules for RTP are found in the private system rules. RTP is also governed by UCC Article 4A as adopted in New York for any non-consumer payments.

“So, while the two real-time payment systems share a lot of similar features, it’s important to understand that they may be governed by slightly different sets of rules,” Vandenberg said.

For RTP and FedNow, a sending bank’s payment to a receiving bank becomes “final” the instant it is recorded in the transaction ledger at the Federal Reserve Bank or by the RTP system. Like with wires, this means that payment—including discharge of any underlying debt—happens simultaneously with the posting of the payment transaction between banks.

Like with wires governed by Article 4A, once a real-time payment is made it cannot be reversed, except by a voluntary return by the receiving bank. While a sending bank may request reversal of a payment and the receiving bank is required to provide a response there is no obligation to reverse a completed payment transaction.

Both real-time payment systems offer features to help mitigate payment fraud, such as multifactor authentication. RTP uses the “tokenization” of users to mask their underlying account numbers. This will assist preventing account information from being inadvertently used or hacked by fraudsters, according to Vandenberg. FedNow permits dollar limits for specific participants of the system and also has a “negative list” of suspected bad actors.

Both payment rails also currently have transaction limits on the size of payments. RTP’s is $1 million, while FedNow launched this summer with a $500,000 limit. (The system default is $100,000.) These caps are intended to restrict the amount of money that can be inadvertently sent, Vandenberg said, but are expected to rise in the future as additional fraud-mitigating technologies are deployed. The dollar caps limit the utility of these payment rails in many real estate transactions because residential property values often exceed them in several markets.

Finally, a feature known as “request for payment” is being developed and is not yet available for real estate transactions. Once available, Vandenberg said, it should be a powerful way to prevent a lot of interloper wire fraud.

“A request for payment will enable a company—like a title agency—to send an invoice or perhaps a settlement statement to a customer asking for payment in the requested amount,” Vandenberg said. “Since the request comes directly from the business, this greatly reduces the risk that some fraudster will intervene and provide false wiring instructions, or that the consumer will mis-key the business’s account number when setting up the payment.

“All together, these fraud mitigating techniques—which are still being developed and more widely deployed—hold the promise of making real-time payments significantly safer than wire transfers are today,” Vandenberg said.