Ever write a check thinking you had plenty in your account to cover it? Make a debit card purchase before your paycheck cleared? How about the time you withdrew $5 too much from the ATM?

Sure, your bank was happy to cover the amount. Why not? Although touted as a customer “convenience,” overdraft fees have been soaring. Last year, overdraft charges generated nearly $24 billion dollars for banks and credit unions. That’s 35% more than just two years earlier, according to the Center for Responsible Lending.

Warning! No Warning

The first problem with overdraft fees is that you don’t receive any notice that the transaction you’re about to make will exceed the balance in your account. If you did, at least you’d be able to choose whether you want to continue with it or not.

In some cases you can trigger overdraft charges even if your online statement shows you have plenty in your checking account! That’s because your balance is “theoretical” and doesn’t reflect the fact that a recent deposit may not have been in your account long enough for the funds to “clear.”

When Does $10=$70?

In addition, you are charged an overdraft fee per occurrenceand are hit with a “sustained overdraft fee” until you deposit enough money to cover the shortfall. With the average overdraft fee now at $35, a $10 overdraft loan can cost up to $70 if not repaid in just five days, according to the Consumer Federation of America (CFA).
In fact, if you look at overdraft protection in terms of a short-term loan, CFA calculates that the average fees on a $100 overdraft repaid in one week is the equivalent of paying an annual interest rate of 1,820%!

What Overdraft Protection?

Consumer groups maintain that overdraft protection is also unfair because bank customers don’t have the ability to accept or refuse it. It’s bundled in with all of the other “terms and conditions” you agreed to when you opened your account.

The Re-ordering Trick

Another criticism is that financial institutions can play games with your transactions in order to trigger a cascade of overdrafts.

For instance, say you make four debit card purchases in a day. Your available balance was $90. The first three transactions were for $25, $20, and $40. The last one was for $100. If taken in chronological order, there is adequate money in your account to cover the first three purchases. Only the last one would result in an overdraft charge.

But that’s not the way your bank computer system is programmed. Instead, it will change the order of your purchases in order to deplete your account sooner by subtracting the largest transactions first.

In the above example, your $100 purchase would come out of your account ahead of the other three. Since it exceeds your balance by $10, it generates a $35 charge. Next, with your account already under water (according to the bank's math), your other three purchases are posted. You end up paying $140 (4 x $35) for the “convenience” of overdraft protection.

Congress Steps In

Kathleen Day, a spokesperson for the Center for Responsible Lending, calls the current state of overdraft fees “ridiculous” and an “outrage.” The Center and other consumer protection organizations place the blame squarely at the feet of the Federal Reserve, which regulates most large financial institutions in this country. 

“The Fed has known for years these practices are hurting customers and they’ve failed to act,” charges Day. The Senate Finance Committee has drafted the “Fairness and Accountability in Receiving Overdraft Coverage Act,” or the FAIR Act, which would limit overdraft fees banks can impose.

Last week, hearings on the bill were jam-packed. But at this stage, there’s no guarantee what it will ultimately look like or if it will even be enacted.

How Not to “O.D.”

At this point, consumers are on their own if they want to avoid overdraft fees. Here are some suggestions:

• Educate yourself. Make sure you know exactly what the overdraft rules and fees are at your financial institution.
• Just say “No.” Find out if you can opt out of overdraft protection. If you do, you will immediately know when you are about to make an overdraft because your debit card purchase will be denied.
• Link to another account. Some banks will pull money from a savings account to cover an overdraft of your checking account. There will also be a fee for this, but it should be less.
• Get a bank line of credit. This is another option if linking to a savings account isn’t available. It’s also a lot cheaper.
• Don’t use a debit card. Debit card transactions are immediately deducted from your account. A paper check takes longer to reach your bank. Use the time it takes for a check to clear to your own advantage.
• Don’t rely on what the bank says is your “available balance.” As previously mentioned, it can include funds that are not technically available.
• “Put a reasonable buffer in your account,” suggests Day. Promise yourself you will not make a purchase that dips into this amount. For instance, your “buffer” might be $100. Know that once your account reaches that level, you cannot make a debit card purchase or ATM withdrawal.
• Don’t O.D. on O.Ds. If you aren’t a chronic over-drafter, there’s a better chance your bank will forgive an occasional mistake.
• Keep better track of your spending. This way you’ll have a more accurate count of the balance left in your checking account.

Ms. Buckner is a Retirement and Financial Planning Specialist at Franklin Templeton Investments. The views expressed in this article are only those of Ms. Buckner or the individual commentator identified therein, and are not necessarily the views of Franklin Templeton Investments, which has not reviewed, and is not responsible for, the content. 

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