How to avoid overdraft fees
OK, so nobody likes overdraft charges. But they're easy to avoid if you stay on your toes – and that's important, because they'll probably keep increasing. “Seriously, this is like complaining about speeding tickets,” said Greg McBride, a senior analyst at Bankrate.com. “Don't speed and you won't have to worry about it.” Here are some tips from McBride and Bankrate:
Keep track of your purchases. Sounds like a no-brainer, but it's the most surefire way to avoid spending more than you have. Develop a system so you won't forget to deduct ATM withdrawals or debit-card purchases. If you have a joint account, be sure to work out a system with your partner.
Consider opting out of overdraft services, which means you won't be able to buy anything with your debit card or make cash withdrawals if you don't have enough money in your account. Almost all banks – 86percent, according to Moebs Services – will let you do this.
Consider signing up for overdraft protection, which your bank probably offers for free. This means your checking account will be linked to your savings account or credit card – or a line of credit, but you'll probably have to pay interest on that. Then, when you overdraw your account, your bank might still charge you a fee, but it will be more like $5 or $10, instead of the $25 or $35 that you'll pay if you don't have overdraft protection.
Of all the bank fees that people love to hate, overdraft charges are among the most detested – and, for the banks, the most lucrative.
Banks usually charge the fees when you overdraw your checking account, either by swiping a debit card, writing a check, or taking cash out of an ATM. The harshest critics liken them to payday loans since they can be so expensive – turning a $3 cup of coffee into, say, a $30 purchase.
Clearly, the drumbeat for consumer rights in the financial industry is growing louder. Credit cards have been the main target so far, with the Obama administration already clamping down on what it views as abusive practices.
Overdraft fees could be the next banking practice to draw high-profile scorn. The Federal Reserve is about to implement new rules about their disclosure, and some lawmakers would like to make the banks at least warn you before they charge them. The recession is also giving a boost to the consumer-rights camp, as people who might not have cared too much about bank fees a couple of years ago are now counting every penny.
The banks say the fees discourage consumers from spending more than they have. Some consumers counter that the fees defy logic.
“If you overdraft, they know you're in the negative,” said Maurice Montrez, a 24-year-old who works as a cable technician in Charlotte. “They don't need to put you in more debt than you're already in.”
Montrez says he recently started paying for all his purchases with cash or prepaid cards, partly to avoid things like overdraft fees.
Another big concern about overdraft fees is how they can multiply so quickly. Generally, every purchase you make on an overdrawn account will trigger a separate fee, with some banks charging upward of $35 each time. And often consumers aren't even aware that they're racking up hundreds of dollars in penalties, since banks don't usually offer a warning when you're about to overdraw your account.The median overdraft fee is up a dollar to $26 this year, though most larger banks charge more, according to a June survey of more than 2,000 banks and credit unions by Moebs Services. Though the increase is slight, Moebs says this is the first time the banks have raised the fees in a recession.
The banks say they're providing a service for consumers, by allowing them to complete what could be vital payments even when they don't have enough money in their account. But they're also eager for the revenue, especially now, as they struggle with loan losses and higher payments to the government to insure deposits. Low interest rates are also squeezing the profits they make on lending money – the main source of income for most banks.
“Banks are doing what airlines and local governments are doing,” said Greg McBride, a senior analyst at Bankrate.com. “They're looking at fees to fill the revenue gap.”
One fee vs. another
Consumers also complain that overdrafts are hard to understand.
There are two types of fees that banks can charge if you overdraw your checking account: an overdraft fee or a returned-item fee.
Usually, if you write a check to buy something but don't have enough money in your account, your bank will use an automated process to decide whether to return the check or spot you the money. The bank's decision is based on criteria such as how long your account has been open, whether it's in good standing, and whether you regularly deposit money into it.
If the bank decides to pay for your purchase – which it often does for less-risky customers – then it will charge you an overdraft fee later, probably $25 to $35.
If the bank decides not to pay for your purchase, it will charge you a returned-item fee, which will also probably be $25 to $35. But the returned check will raise a host of other problems: The merchant will probably slap you with another fine, and your transaction won't go through, which can be a big problem if you're trying to pay something like your utility bill.
In a letter this spring to regulators, the Financial Services Roundtable defended overdraft fees by pointing out that they're actually more consumer-friendly than returned-item fees, since they protect people from those extra headaches.
That argument worked better when people were still writing a lot of paper checks. But now they're using debit cards for many of their everyday purchases. And a lot of them got debit cards instead of credit cards because they thought the debit cards would keep them from spending more than they have in the bank.
But most banks will automatically set your account so that you can overdraw your debit card, and on top of that, most don't give any warning when you do. According to a report released last year by the FDIC, 89 percent of banks that allow overdraft don't tell customers when their debit card purchase will create an overdraw until after the transaction has gone through – and the fee has already been charged.
“With a check, people can say, ‘Well, it's my fault. I wrote the check,'” said Marc Fusaro, a professor at East Carolina University who studies consumer banking habits. “With a debit card, their thought tends to be, ‘Well, why didn't you just decline it?'”
The banks say their hands are tied because of merchants' technologies and policies. “If you go to Wal-Mart, that's Wal-Mart's machine, so we can't provide a notice on their machine,” said Cynthia Williams, spokeswoman at Winston-Salem-based BB&T Corp.
Bank of America says a survey of its customers shows that most would rather have their purchase go through without a warning, and pay a fee later, than suffer the embarrassment of having the cashier announce that their account is depleted.
“You might not want the cashier in the grocery stores to see on their screen, and everybody in line behind you can see, ‘Oh, your account is overdrawn. Do you want to continue with the transaction?'” said Mike Moebs, an economist and the CEO of Moebs Services.
Most banks will let you set your account so that you cannot overdraw your debit card, but you'll probably have to approach the bank about it.
Overdraft fees are a big moneymaker for the banks. Moebs Services, which is an economics research firm whose clients include the Federal Reserve and the Government Accountability Office, estimates that banks brought in nearly $37 billion in overdraft revenue in 2008. That's up from $34 billion in 2007, and about $16 billion in 1998.
The FDIC estimates that overdraft-related fees account for nearly three-quarters of the revenue that banks make in service charges on deposit accounts.
Charlotte-based Bank of America Corp., the country's largest bank by assets, told customers this year that it was going to raise its overdraft fee from $35 to $39. But the bank backed down in April, citing the slow economy and, particularly, the rise in unemployment. It also dropped the fee to $10 for the smallest overdrafts, and its Customer Assistance program waives fees for people who have lost their jobs.
However, the bank has also raised the number of overdraft fees allowed each day from five to 10, and introduced a new, one-time fee of $35 for customers whose accounts remain overdrawn for five business days.
Bank of America and its peers point out that customers can easily avoid overdraft fees if they just keep track of their money. In fact, many offer services such as text or e-mail alerts when an account drops below a certain balance. Most also offer overdraft protection, which is where you can sign up, usually for free, to link your checking account to a credit card, savings account, or line of credit. The bank might still charge you if you overdraw, but the fee will probably be lower – more like $5 or $10.
“My sense is that most people don't pay any overdraft fees at all,” said Bert Ely, a Virginia-based banking consultant. But, “there's a substantial portion of the population that does a lousy job of keeping track of these things, and that includes people who are very well educated. It only takes a couple of (overdrawn) transactions for them to blow through their cash, and then they're really in a hole.”
About 26 percent of consumers overdraw their account at least once during a given year, according to the FDIC study. Twelve percent of all consumers overdrew one to four times, and were charged an average of $64 total. About 5 percent overdrew 20 or more times, racking up $1,610 in fees. Young adults ages 18 to 25 were the most likely to overdraw. Low-income families were more likely to overdraw than high-income.
For customers who slip up only occasionally, an overdraft fee can actually be a good option, even if it is expensive, Ely said.
“You've got a basket full of groceries and a couple of screaming kids, or you're almost out of gas at the gas pump – you want that payment to go through that one time,” he said.
So far this year, credit cards have been the main scourge of many a consumer advocate. In May, just four months after he took office, President Obama signed into law the Credit Cardholder's Bill of Rights, a sweeping set of rules that curbs interest rate increases, forbids late-fee traps, and requires greater disclosure to consumers.
Now there are overdraft changes on the horizon. The Federal Reserve has adopted regulations, which will take effect Jan. 1, requiring all banks to disclose on customers' statements how much the person has accumulated in overdraft fees for that statement period and for the year.
Separately, the Fed is considering two other requirements related to overdraft fees. One would require banks to alert you when your debit-card purchase or ATM withdrawal is about to trigger an overdraft, and give you the chance to back out. The other option, which the banking industry favors, would require banks to inform you of your right to opt out of overdraft service – meaning your account would be set so you couldn't overdraw.
The Fed says it expects to act on these proposals by the end of the year.
The agency had considered implementing such requirements for almost all methods of payment – not just cash withdrawals and debit-card purchases, but also things like checks and automatic withdrawals. But it backed off in December, saying the “operational issues” were complex and could benefit from further study. The banking industry had lobbied hard against the proposals.
Rep. Carolyn Maloney, a New York Democrat who pushed for the Credit Cardholder's Bill of Rights, introduced something called the Consumer Overdraft Protection Fair Practices Act in March. Like the Fed proposal, it would require banks to inform customers when a cash withdrawal or debit-card purchase is about to send their account into the negative. It has been in a subcommittee since it was introduced in March.
Rep. Brad Miller, a Raleigh Democrat who is co-sponsoring the bill, thinks it could be folded into the Obama administration's plan for a new regulatory agency that would look out for consumer interests. That broader plan might be a better way to protect consumers, Miller said – “so Congress isn't chasing after each new scheme the banks come up with to gouge consumers.”