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What is a bank draft and how does it work?

What is a bank draft and how does it work?

Looking for a secure, reliable form of payment? Bank drafts can be perfect for large payments and are regarded as more secure than a personal check. What is a bank draft, and how does it work? Here's how bank drafts can enhance your business processes and expand customer payment options.

What is a bank draft?

The term "bank draft" (also called a banker's draft, bank check, or teller's check) is a paper document that resembles a traditional paper check. But unlike personal checks, a draft is guaranteed by the issuing bank, with no chance that the check could bounce.

Bank drafts provide merchants and business owners with a secure form of payment since each draft carries a guarantee from a trusted financial institution.

How do bank drafts work?

Bank drafts work the same way that a check does, though the document is prepared by the issuing bank and not the customer directly. Here's a step-by-step explanation of how this process works.

1. The customer requests a bank draft

A customer initiates the process by requesting a bank draft from their bank, credit union, or other financial institution. The bank will verify that the requester's account contains enough money to cover the customer's request. Some banks may charge a small fee, though others may offer free bank drafts to those who make frequent payments of this type.

2. The bank withdraws money from the customer's bank account

The bank will withdraw the requested funds from the customer's bank account and deposit them into a separate account owned by the bank. This step means that technically the bank, rather than the customer who made the initial request, becomes the paying party.

3. The bank issues a draft

The bank can now prepare a physical document containing the payee's name and amount. The draft will have other identifying information, including a serial number, watermarks, and possibly micro-encoding. But because the bank issues the check directly, it will not contain the customer's account number like a regular check.

What is the difference between a draft and a check?

On the surface, a bank draft may sound similar to other forms of payment. Here's how a bank draft differs from other common secure payment types.

Bank draft vs. check 

A personal check comes directly from the customer. Business owners have no way of knowing whether there's enough money in the payer's account, and there's a possibility that the check can bounce.

But a draft is backed by the customer's bank, which has already withdrawn the necessary funds. This makes bank drafts a more reliable payment option than traditional checks.

Bank draft vs. cashier's check 

Bank drafts are often confused with cashier's checks since they're both guaranteed by the issuing bank and are often involved in large payments. But while a bank draft is issued to the customer, a cashier's check is issued directly from the bank to the final recipient.

Bank draft vs. certified check

A certified check works similarly to a bank draft in that the bank guarantees that the money is in the customer's account. But a certified check simply "freezes" or holds the money in place until the check is cashed, while a bank draft removes the money entirely to ensure payment.

In addition, a bank draft doesn't need a customer's signature but is signed by a bank official, enhancing security. A certified check, however, needs the customer's signature, and the bank adds the word 'certified' to the signature.

Bank draft vs. money order

Money orders are also guaranteed by banks and other financial institutions, though money orders can be made only for the maximum amount of $999.99.

You don't need a bank account to send a money order, and you can obtain money orders from your local post office. Bank drafts have no such limits, which makes them ideal for large purchases.

One important thing to note is that money orders can be canceled and refunded if not already withdrawn whereas bank drafts cannot.

Bank draft vs. automatic payment

Some resources will use the term "bank draft" as a catch-all for automatic payment, such as those that occur through an Automated Clearing House (ACH) network. But while the mechanism behind these automatic payments can vary, bank drafts always follow the clear procedures outlined above.

If you ask to be paid through a bank draft, ensure your client or buyer understands that you're expecting a physical check, not merely an electronic transfer.

Is a bank draft as good as cash?

In many cases, a bank draft is better than cash. The bank's guarantee means that you can have confidence you've received a legitimate bank draft, and you can use the information on the check itself to contact the bank should there be any questions.

A draft is often more secure than keeping a large sum on hand after a customer makes a big purchase. Additionally, bank drafts can be issued in a variety of foreign currencies, which makes bank drafts an excellent option for international transactions.

On the other hand, bank drafts are only as reliable as the financial institutions that issue them. It's possible that a bank's accounts could be depleted, rendering them unable to honor outstanding drafts.

Fortunately, most major financial institutions are FDIC-insured, protecting against insolvency or insufficient funds.

Bank drafts are physical documents. Like cash, they can be lost, damaged, or stolen. The person receiving a draft can guard against this by depositing the funds into their account as quickly as possible.

What is the point of a bank draft?

Because bank drafts are guaranteed by the financial institutions that issue them, they are the ideal payment option when customers make a large purchase. And unlike cash, a bank draft provides a clear, secure record of the transaction. This can be important if there's any future dispute about the transaction.

A more secure payment option can protect you and your business from scams. Customers may likewise appreciate the ability to send a check by mail without including their sensitive bank account information.

These secure payments can also prevent you from being the victim of a bounced check, which can take time to track down to recoup your loss.

Additionally, a bank draft is more secure than keeping a large amount of cash on hand. Many online banks allow you to deposit funds electronically, saving you a trip to a branch location.

When to use a bank draft

As a business owner, there may be times when it makes sense to ask a person to pay with a bank draft. For example, you might ask to be paid by this method when:

  • Customers make large purchases
  • A transaction involves a significant sale price
  • You don't have a relationship with the buyer
  • Other forms of payment would be too difficult

For example, drafts can be ideal when a customer purchases a large-ticket item such as a car or real estate property. But depending on your business, you might ask clients to pay with a draft when purchasing large volumes of products or when paying for a larger project. Similarly, your suppliers may ask you to pay with a bank draft when ordering new inventory.

Pros and cons of a bank draft

Every payment option has its pros and cons. Here are the advantages and disadvantages of bank drafts.

Advantages of bank drafts

There are many benefits of using a bank draft, including:

  • Payments guaranteed by a trusted bank
  • No limit or maximum amount
  • Available in multiple foreign currencies

These benefits make bank drafts a better form of payment than simply a check or money order, and they even give some flexibility in terms of purchase price and currency type.

Disadvantages of bank drafts

Despite these advantages, there are some drawbacks to using a bank draft, including:

  • The person making a payment may be responsible for additional fees
  • Each draft is a physical document that can be lost or stolen
  • The process of issuing a bank draft can be time-consuming

Bank drafts bring an added layer of security, though they can slow the sales process down. Still, if businesses use bank drafts on a selective basis they can be helpful when making unusually large transactions.

How to get a bank draft from your financial institution

To get a bank draft, simply request one from your financial institution. A teller can verify your account details and confirm that you have the funds necessary to make the transaction.

The bank will withdraw the requested funds and deposit them into an internal account, then issue you a draft that you can take with you.

Depending on your institution, you can complete the process electronically rather than visit a brick-and-mortar banking location. Some banks may also allow business owners to submit requests via fax.

The easiest way to secure a bank draft is by requesting one from your bank. But many banks allow you to obtain a draft even if you don't have an account. In this case, you'll have to pay upfront, using cash or a debit card, but the bank can issue you a check once they have these funds.

The process may be even easier if you're a credit union member. Many credit unions participate in shared branching, which means you can walk into participating credit unions to obtain any bank drafts you need.

Keep in mind, however, that you'll pay a fee each time you go through this process. And if you receive drafts from banks outside your network, fees can potentially be higher.

Convenient alternatives to bank drafts

Consumers and business owners can also send money using an alternative to drafts, such as a certified check, cashier's check, or money order. But the following methods may be an even more convenient way to send money quickly and securely.

Wire transfer

A wire transfer allows you to transfer money from one account to another. You'll simply need the recipient's banking data to make the transfer, though if you transfer funds between different financial institutions you'll have to pay an additional fee.

Money transfer apps

A growing number of personal finance apps allow users to send money between users quickly and securely. There may be a fee depending on the type of service you use, however, and some apps may limit your transfers or hold funds if you attempt to transfer a large amount all at once.

ACH payments

ACH payments likewise allow users to transfer funds between financial institutions. The Automated Clearing House network allows you to complete transfers between virtually any bank or credit union, provided you know the financial data of your recipient.

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FAQs

Is a bank draft as good as cash?

In many cases, a bank draft is better than cash. The bank's guarantee means that you can have confidence you've received a legitimate bank draft, and you can use the information on the check itself to contact the bank should there be any questions.

A draft is often more secure than keeping a large sum on hand after a customer makes a big purchase. Additionally, bank drafts can be issued in a variety of foreign currencies, which makes bank drafts an excellent option for international transactions.

On the other hand, bank drafts are only as reliable as the financial institutions that issue them. It's possible that a bank's accounts could be depleted, rendering them unable to honor outstanding drafts.

Fortunately, most major financial institutions are FDIC-insured, protecting against insolvency or insufficient funds.

Bank drafts are physical documents. Like cash, they can be lost, damaged, or stolen. The person receiving a draft can guard against this by depositing the funds into their account as quickly as possible.

How long does a bank draft take to clear?

Most checks take several days before you receive funds in your account. But bank drafts clear much more quickly, often appearing in your account within 24 hours. That's because the issuer's guarantee means fewer steps are needed to verify that the money is present.

Can I cancel a bank draft?

Generally speaking, you won't be able to cancel bank drafts once they've been issued. Some banks may permit you to cancel drafts under extraordinary circumstances, but these policies are strict — and rare. Usually, this option is reserved for confirmed fraud cases, and even then it's difficult to cancel the check once it's been made and sent.

The best way to "cancel" this type of check is to have the person receiving the check cash it and return the funds directly to you, but this assumes that the receiving party is in agreement with the need to return the funds.

Fast. Easy. Secure. That's payments with BILL.

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