Automatic Overdraft Protection: Just Say No

Last Updated Aug 19, 2010 1:34 PM EDT

Just say no, when your bank or credit union asks if you want "courtesy" overdraft protection for purchases made with your debit card. This so-called service damages your finances and handed the banks $37.1 billion in fees last year, Moebs Services reports. Most of that money was drained from the accounts of people living paycheck to paycheck.

New regulations, effective August 15, stopped the lenders from hitting you with debit-card overdraft fees automatically. Now you have to specifically agree to the charges, either when you open an account or by signing up for the program later. But who would agree to these abusive fees if he or she knew all the facts? There are cheaper ways than this one of getting the protection you want.

The automatic overdraft started about a decade ago. Until then, banks turned down debit-card purchases if you didn't have enough money in your checking account to cover the bill. The same was true if you tried to overdraw your account at an ATM. "Sorry," the screen said, "you don't have the scratch." That's the way prudent money management is supposed to work.

Then the banks had a Eureka moment. Instead of turning you down, they let you overspend and charged you a "courtesy fee" for letting the transaction go through. Moebs puts the median fee at $27 for every overdraft, even if the bill runs just $1 or $5 over the amount you have in your account. Some banks charge the fee if you're a penny over. Effectively, you're getting very short-term credit at effective interest rates that reach the high triple digits.

At the big banks that allow overdrafts, the median fee is $35. They charge another $7 to $36 if you don't repay the overdraft within a few days, according to a 2010 survey by the Consumer Federation of America. (Citibank never allowed debit-card overdrafts unless you arranged for some sort of backup line. Bank of America recently ended them.)

There are much better ways of getting overdraft protection from banks, which are detailed below. But don't expect banks to volunteer that information. They're engaged in aggressive marketing campaigns to sell you on the "courtesy" program that will cost you the most.

In their marketing calls, emails and brochures, they grab you with anecdotes. For example, they warn that -- without the program -- you might have a debit card refused at the grocery checkout because you're overdrawn by the cost of a $1.50 tin of tuna. Ooooo, that sounds bad, so you sign up.

Personally, I'd rather put the tuna fish back than pay a $35 overdraft charge.

The tuna fish is the least of it. If you left the grocer and used your debit card for coffee and donuts on the way home, that's another $35 in overdraft fees. A stop at the drugstore for vitamins and aspirin would cost you another $35. You've just racked up $105 in penalties, for minor expenditures that you wouldn't have made if you'd known about the fees. And you won't know they were overdrafts until you log into your online account or get a letter or email from the bank.

The banks mislead you by saying things like, "Act now, or your debit card transactions will be denied," according to Linda Sherry, spokesperson for Consumer Action. "You think you'll be in trouble if you don't sign up. They don't explain that the reason for the denial is that you don't have the money in your account."

They also say, "Sign up, if you like the way your account is working now." Most customers rarely experience overdrafts, so they might accept the program without realizing the size of the fees they're potentially exposed to.

If you want overdraft protection, and many of us do, there are three cheaper ways of getting it. First, put money into a savings account and link it to your checking account. If you overdraw, the bank will take the needed money out of your savings, charging perhaps $5 for the transfer. Alternatively, sign up for a personal line of credit to be used for overdrafts, or link your checking account to a line of credit on your credit card. These are all better choices than the "courtesy" overdrafts that drill into your wallet.

What if you have no savings and don't qualify for a line of credit? You're better off having excessive transactions turned down, says Rebecca Borne, senior policy counsel at the Center for Responsible Lending. Serial overdraft fees just make it harder to pay future bills.

The new regulations cover only debit-card purchases and ATM withdrawals. Banks and credit unions still levy expensive overdraft fees if they honor a check that you wrote for more money than you have in your account. The same is true if you've signed up for automatic bill payments and can't cover the debit when it's due. To opt out of these fees -- and still have protection -- you have to call the bank and say that you want one of the three cheaper options instead.

You might think that you can avoid overdrafts by keeping your check register up to date or monitoring your account online. But it's not that easy. There's another piece to this story of abuse -- and another reason to say no to automatic debit-card overdrafts.

About half of the banks (and most of the big ones) "engineer" the way they cover debits, to make it more likely that you'll have to pay multiple fees. As a result, you can rack up 10 or more $35 fees in a single day, from a string of small purchases that you thought you had enough money to cover.

A recent court decision, in a class action lawsuit, called this bank practice "gouging and profiteering." That's a story for next time.

More on MoneyWatch:
Five Ways the Financial Reform Law Changes Your Money Habits
Financial Reform: A Big Win for Consumers, a Big Loss for Investors
The Dangers of Using a Debit Card
  • Jane Quinn

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