Overdraft loans have evolved from an occasional bankers’ practice, truly meant as an accommodation, into a high cost credit product that rakes in billions for banks every year. Generally under overdraft programs, if you overdraw on you account, your institution pays for the transaction and charges you a fee. Your bank will also require you to repay the overdraft amount out of your next deposit.
Prior to overdraft loans, banks traditionally returned a consumer’s check if the consumer did not have sufficient funds in his.her account to cover the check. The bank would charge the consumer a non-sufficient funds (NSF) fee as a penalty, to discourage the consumer from writing checks without funds on deposit to cover them. The consumer might also be charged a second fee by the merchant.
In some cases on an ad hoc basis for their preferred customers, banks would cover a transaction that would otherwise “bounce,” for which they charged an overdraft fee, usually the same amount as the NSF fee. Bank managers would make the decision on an individualized basis as to which customers’ checks would bounce and which customers’ checks would be covered as an overdraft. Bank managers also had the discretion to forgive overdraft fees for individual consumers. However, within the last two decades “bounce protection” or “courtesy overdraft” plans, have become an automatic practice for customers who have “opted in” to the program.
By law, financial institutions are required to ask you to “opt in” to the overdraft protection program, but few people fully discern the potential impact of what they’re signing or even recognize their ability to “opt out.” The matter is often further complicated by the complex methods institutions take when they clear transactions, with many banks reordering transactions by dollars amounts from highest to lowest, causing accounts to be overdrawn more quickly and incurring more fees.
Overdrafts: From Courtesy to Usury
G.C’s case is typical of overdraft loan complaints that consumer advocates receive. G.C., a college student, uses his bank debit card and spends $5.28 at a local coffee shop and $8.26 for lunch. For less than $14 in goods, he was charged $70 in overdraft fees. Even if G.C. didn’t make a deposit and clear up his overdraft for two weeks – his next pay day – the Annual Percentage Rate on the loan would have been $13,458%.
That rate pales in comparison to the rate on a typical two-week payday loan. Payday loan rates of $15 per $100 fee equates to an annual percentage rate (APR) of almost 400%.
With such outrageous interest rates, no wonder financial institutions are so generous at disseminating overdraft credit to their customers. By charging such exorbitant fees the institutions are guaranteed ample income to cover losses for those who default and still make huge profits.
Beginning in 2015, banks with more than $1 billion in assets were required to report to the Federal Financial Institutions Examination Council the fees they collect on consumer accounts in overdraft and NSF fees. For the fourth quarter of 2015, there were 628 banks subject to the requirement. For 2015, these banks reported consumer overdraft and NSF fee revenues totaling $11.16 billion, accounting for 8.0% of their total net income. NSF and overdraft fees represented 65.3%, or almost two-thirds, of all reported consumer deposit account fee revenues from these banks.
“This is a huge amount of money for the banks,” said Jean Ann Fox, director of financial services at Consumer Federation of America. “Aren’t we in trouble if the only way banks stay afloat is by sticking their most desperate customers with the highest priced credit.”
A Pew Charitable Trust Report released this week verifies overdraft protection hurts the most vulnerable. According to their study, while only a small proportion (18%) of account holders pay the vast majority (91%) of all overdraft fees, for these consumers, overdraft service is not just an occasional courtesy but an extremely expensive form of credit.
The Pew Report surveyed “heavy overdrafters,” those who incurred over $100 in overdraft and non sufficient funds. The survey found notably that most heavy overdrafters are millennials or Generation Xers; more than half are renters rather than homeowners; they generally have below-average incomes relative to the U.S population; and overdraft fees consumed nearly a full week’s worth of their household incomes on average during the past year.
Overdraft fees cause some of the most financially vulnerable consumers to leave the banking system. Thirty-one percent of those without a bank account reported high or unpredictable account fees as one reason for not having an account; 13% said it was the primary reason.
The Float is Gone
“Back in the day, you could write a check and it could float for a week,” advised Angie Franklin, manager of the Wichita Branch of Great Plains Credit Union in reference to the time is used to take for banking transactions to actually impact your bank balance. “It doesn’t work like that anymore.”
With connected computers and online processing of financial transactions, money moves at the speed of the internet. Robert Giltner of Sheshunoff Management Services, a third party vendor that provides overdraft loan consulting services, admits “electronic transactions are part of the reason for the doubling in overdraft volume in 10 years,” admitted Giltner. “As velocity increases, as things clear faster, … customers are not able to respond as fast on the deposit side as they are on the transaction side.”
In a testimony during a congressional committee hearing on Overdraft Protection, Atty. Chi Chi Wu, with the National Consumer Law Center was particularly disturbed by what she sees as the particularly deceptive practice of banks approving overdrafts on debit transactions. While these transactions are on-line and real time, banks still confirm the availability of funds and set up an overdraft of the customer’s account.
“Intentionally permitting overdraft loans for ATM and debit card transactions is an especially egregious practice, which serves no other purpose except to rack up enormous fees for banks,” testified Wu. The decision of a bank to program its computers to permit overdrafts when there are no funds is a a deliberate and unfair act.
While financial institutions defend overdraft loans by claiming they save consumers from merchant penalties, late charges, and embarrassment, Wu contents that there is little or no truth to their defense. Because debit card transactions are at the point-of-sale, if the transaction is declined or at least the consumer often has the ability to undo the transaction (i.e put the merchandise back on the shelf) or use an alternative form of payment without incurring a hefty penalty.
“While there is a third party involved and perhaps a chance of slight embarrassment if a transaction is declined, that risk is preferable to a hefty $20 to $35 fee per each transaction,” observed Wu.
Banks also often defend permitting overdraft loans by ATM and debit card by turning around and blaming the consumer. They argue that the consumer has failed to keep track of his or her transactions, and lacks “personal responsibility.” Again, Wu doesn’t agree, instead saying banks have programmed their system to permit and encourage these so-called transgressions.
“The bank could easily re-program its computers to decline overdrawn debit card transactions without imposing a fee, like they used to,” said Wu. “The banks’ actions are akin to putting a trip wire in front of a person, then blaming the person when they trip. While the person may not have been careful in watching the ground, the bank bears responsibility for laying down the trip wire in the first place.”
Another defense of financial institutions is that individuals have “opted in” to the overdraft protection program. That’s true. Financial institutions are required to get your approval for the overdraft program. Many people may not remember “opting in,” but many financial professional recommend “opting out.”
How you can reduce or eliminate overdraft fees?
You can opt out of overdraft protection programs anytime. This means that your debit of ATM card may be declined if you don’t have enough money in your account to cover a purchase or ATM withdrawl. However, it also means you won’t be charged for these transactions.
Link your checking account to a saving account. If you overdraw your checking account, your bank will take money from your linked saving account to cover the difference. You may be charged a transfer fee when this happens, but it’s usually much lower than the fee for an overdraft.
Ask your financial institution if you’re eligible for a line of credit or linked credit card to cover overdrafts. You may have to pay a fee when the credit line is tapped, and you will owe interest on the amount you borrowed, but this is still a much cheaper way to cover a brief cash shortfall.
Track your balance as carefully as you can and sign up for low balance alerts to let you know when you’re at risk of overdrawing your account. If you have regular electronic transfers, such as rent, mortgage payments or utility bills, make sure you know how much they will be an don what day they occur. You also need to know when the funds you have deposited become available for your use.
Shop around for a different account. Get a copy of your bank or credit union’s lit of account fees, or ask about them, the compare them with account fees at other banks or credit unions. Assess your habits honestly and consider penalty fees, such as overdraft and non-sufficient funds charges, as well as monthly maintenance, ATM surcharge, and other service fees.
When comparing banks or credit unions, also consider factors such as hours of operation, locations, access to public transportation, available products and services, and reputation for customer service.
