Overdraft protection: Are you in or out?

Young woman agonizing over debt card protection choiceThat magical date has finally arrived. As of August 15, banks now have to ask you whether you want to opt in or opt out of overdraft protection.

If you haven't made a decision yet, no need to panic, the bank, or rather, the Federal Reserve, has made the choice for you: You'll no longer have overdraft protection at your bank when you make purchases with your debit card. So if you end up going to get a burger at a fast food restaurant and you don't have enough money in your account to pay for it, your card will be declined. In the past, you'd get the burger -- and a $30-something fee.

This new rule applies to debit card purchases only. The bank can still automatically charge you an overdraft fee for non-sufficient funds on a check or an automatic withdrawal for, say, your car insurance.

If you're still on the fence about overdraft protection on your credit card, it might be worthwhile to think about the pros and cons. And while I had a hard time coming up with any truly good reasons to opt in for overdraft protection, I'll try to make an argument for doing it, just so you can look at the issue objectively.

Why you should think about getting overdraft protection:

While the stakes are pretty low that your opportunity to eat a burger might be sidelined because your card is declined, what if you're somewhere far away from home, low on gas, and your debit card is declined? Then you could be in a pickle. Or what if your child was sick and you're at the pharmacy in the middle of the night, and your card is declined? Again, not a situation you want to find yourself in.

The thing is, anybody -- especially someone who works for a bank -- can drum up some logical scenarios why overdraft protection sounds like a smart idea. I mean, you should always have a back-up plan, some insurance in case something goes wrong with your account, right? And that's what overdraft protection is supposed to be. It's a way of ensuring you won't run out of money. But you have other options. For instance, there's the obvious: putting money in a savings account -- or even stuffing some petty cash into a shoebox and putting it way up high on a shelf, just in case you need it.

Why you should opt-out:

It can be easy to forget that if your overdraft protection kicks in and the bank allows you to make your purchase, you have run out of money, and now you're taking out a loan from the bank. They're fronting you the cash for that medicine or burger and then charging you something like $37.50 on top of it. And since you have to pay back the cost of the medicine or burger plus that $37.50 right away in order to use your debit card and avoid more fees, it's not even a very good loan. I hate to say this, but most payday loan services have better terms.

"Let's say you make a $100 purchase but are overdrawn," says Jason Biro, the founder of the nonprofit Saving Your American Dream and author of the Saving Your American Dream: How to Secure a Safe Mortgage, Protect Your Home, and Improve Your Financial Future. "Your bank charges you $30. Essentially, you're being charged 30% interest for this one transaction. In this particular case, if you really need the item, you'd be better off charging it to a credit card."

And while not everyone has a credit card these days and some of the truly financially desperate are living paycheck to paycheck, I can completely understand why it might seem like a good idea to have that overdraft "protection." But I know from experience that, especially if you wind up with several $37 fees at one time, overdraft protection just winds up making a bad situation much worse. Usually, you're trading a short-term money problem for another, bigger money problem.

Overdraft protection protects the bank. I don't think it does much to protect a customer. And for the record, yes, I have opted out.

Gail Cunningham, spokesperson for the National Foundation for Credit Counseling, calls people who rely too much on overdraft protection "serial overdrafters." According to Cunningham, these serial overdrafters "would defend their actions by saying that their purchases are legitimate, and they can't be caught in a situation where they can't buy groceries, medicine, etc. However, that begs the question of how people survived before overdraft protection existed."

If you're worried, Brio, who has opted out himself, points out that you can ask your bank to link your checking account to another account at your bank. That's what he's done. Then if you run out of money in your checking account, assuming you have some backup money in the other account, you'll be protected. Some banks will still charge you an overdraft fee for using the money in your other account, but it's a much lower fee, somewhere around $5 to $10.

If you're still thinking that maybe you should opt in, look at it this way: "Many believe," says Cunningham, "that the banks launched extensive campaigns to encourage people to opt in to overdraft protection, with those campaigns targeted at the very people who can least afford the fees." If you've paid a lot in overdraft fees already and are strongly considering opting in, maybe that means your bank's mind games have been successful at persuading you.

Obviously, when it comes to your money, you're the one who has to decide what's best for you -- your bank can't decide for you. Fortunately, that magical date I referred to isn't really magical. It's not like on August 15, everything is set in stone forever more. If you opt in and ask for overdraft protection and are later hammered with overdraft fees, see the light and regret your decision, you can always reverse it -- and opt right back out.

Geoff Williams is a frequent contributor to WalletPop. He is also the co-author of the book Living Well with Bad Credit.
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