Bank Overdraft Fees Still Plague American Consumers
Last year, the Federal Reserve changed the rules on how banks handle debit card overdrafts, requiring them to obtain customers' permission before allowing purchases or withdrawals that would leave an account with a negative balance, then hitting them with a penalty fee for the privilege. But despite the new opt-in rule, overdraft fees continue to be a costly pain in the neck for millions of Americans.
Seeing a threat to a multibillion-dollar revenue stream, the banks responded with pro-overdraft marketing campaigns that inappropriately targeted their customers, says the Center for Responsible Lending.
Earlier this year, Bank of America (BAC) agreed to pay $410 million to settle a federal lawsuit alleging the bank charged excessive overdraft fees. That suit was just one of several filed against banks from plaintiffs in 14 states that were consolidated in a federal court in Florida. Other banks named in related suits include Wells Fargo (WFC) and Citibank (C). Banks have been taken to task for specifically processing payments from largest to smallest, a way designed to cause more overdrafts, rather than chronologically.
A recent study from The Pew Charitable Trusts, Hidden Risks: The Case for Safe and Transparent Checking Accounts, found that overdraft penalty fees are disproportionate to the size of the average overdraft amount, and that the penalties cost consumers tens of billions of dollars each year. In fact, these charges are estimated to cost Americans $38.5 billion in 2011, which is an increase of $18.6 billion since 2000, according to Pew. While banks do incur a risk that they won't be repaid when they approve such transactions, most institutions manage this by limiting the overdraft coverage given to each individual costumer.
According to Pew, the median overdraft penalty fee is $35, up from $27 in 2007. If overdrafts were considered like a short-term loan with a repayment period of seven days, then the annual percentage rate, or APR, on the typical overdraft would be over 5,000%. Additionally, Pew found that as of October 2010, when the data was collected, all 10 large banks it examined retained the right to re-order withdrawals from the highest to lowest amount, and eight out of the 10 banks reserved the right to post withdrawals before deposits -- both practices designed to manipulate account balances to produce the maximum number of overdrafts. Since then, several banks have reformed these practices.
Misleading Marketing Keeps Overdraft Fees Rolling In
"It is exceedingly difficult for the average consumer to find the basic information needed to either select a checking account or to responsibly manage the one they currently have," said Shelley A. Hearne, managing director of The Pew Health Group, in a prepared statement. "We are calling on policy makers to ensure that overdraft fees are reasonable and proportional."
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The Center for Responsible Lending survey showed that most people don't want high-cost overdraft coverage for their checking accounts, and that opt-ins are largely based on aggressive and misleading marketing rather than clear and accurate information from banks.
Daniel Wesley, operations manager from CreditLoan.com, says he was pressured several times by his bank to sign up for overdraft protection. Eventually, he gave in and signed up. "At first, I felt a safety blanket with my checking account until I found out that the savings account that I was required to open in order to sign up for overdraft protection cost me $25 a month. After about four months, I decided that the overdraft protection was not for me. Since I took more responsibility in my bookkeeping, I found it quite easy not to overdraft," says Wesley.
However, when he tried to cancel the overdraft protection, "I found that it was so difficult to do so because of the pressure that was put on me," he says. "I ended up closing my accounts with that bank and going to another one, and have never since considered overdraft protection."
His story is not unique. The Center for Responsible Lending says banks' marketing materials often created the false impression that emergency action was needed on the account. Some examples from the bank letters on file with CRL include: "We Need to Hear From You ... To keep your account operating smoothly ... To avoid any interruptions in how we service your account, we need to hear from you." "Your Debit Card May Not Work the Same Way Anymore Even If You Just Made a Deposit," and "Save Money by Avoiding Retailers' Returned Check Fees."
Not the Service Consumers Think They're Paying For
Despite all the hype, according to the CRL, only 33% of account-holders opted-in for overdraft coverage. Nearly half of those who opted in did so to stop the bank from bombarding them with opt-in messages by mail, phone, email, in person and online banking. Some 60% of those who did said they wanted the overdraft protection to avoid a fee if their debit card was declined. But in reality, a declined debit card costs you nothing. And 64% said they opted in to avoid bouncing paper checks -- but the opt-in rules don't apply to checks: They cover only debit and ATM transactions.
Clearly there's a severe disconnect between what banks customers think they're agreeing to, and the "service" that the banks are offering with opt-in overdraft protection.
To dispel some of that confusion, the Federal Deposit Insurance Corporation's website, offers a quick primer on overdrafts.
Overdrafts 101
Let's start with the basics: As the FDIC explains.
An overdraft can occur when you try to spend more money than you have available in your checking account. For example, let's assume you have $40 in your account. You ask the phone company to electronically deduct $35 from your checking account to pay the bill. You now have $5 available. Next, you use your debit card to make a $10 purchase. You could overdraw your account if the bank allows the $10 purchase to be processed. This could cost you expensive overdraft fees. The amount you are overdrawn plus your bank's fees will be deducted immediately, in full, from your next deposit(s) -- including from payroll deposits made by your employer, government benefit deposits, and other direct deposits on which you may depend. These deductions will lower your account balance once again and may increase the risk of more overdrafts and costly fees.
More importantly, notes the FDIC's guide, you can protect yourself from high overdraft fees for free, simply by being careful.
1. Watch your balance
Track the money you deposit into and with draw from your account. You can do this on a paper check register or electronically. Remember to track ATM withdrawals, purchases you make with your debit card, bills that get debited electronically from your account, and checks. It also may be a good idea to keep a cushion of funds in your account to help prevent unintended overdrafts.
2. Link your checking account to a savings account
If the accounts are linked and you do not have enough money in your checking account to cover a transaction, the bank will transfer funds from your savings account to your checking account to cover the difference. This can save you money over other overdraft programs because most banks will only charge you a small fee, if they charge at all, for transfers. But, this option is useful only if you have enough money in the linked savings account to cover the transaction. Otherwise, ask your bank about other less costly alternatives to over-draft payment programs, such as a linked line of credit or affordable small-dollar loan.
Despite the issues, some bank customers say they find overdraft protection is worthwhile.
"My wife and I are very happy that we signed up for overdraft protection on our checking account, as this service has saved us from not only the embarrassing situation of bouncing a check, but also the fees associated with that," said Steven Elliott in an emai interview. "Depending on the bank and the arrangement, I have always found this to be a great option. This is a FREE safety step with both banks (between savings and checking) as well as credit cards (to make minimum payments). I've never been charged for this from any bank or credit card company," added Elliot, who, it should be noted, has no history of overdrawing.
Banks are still feeling the pain from the fee income they lost with the passage of the Obama administration's consumer-protecting Credit CARD Act and other industry regulations. But those financial institutions may yet have the last laugh -- they continue to cash in on careless consumers.
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