Vision Credit Education, Inc.

Most consumers with a debit card have done it once or twice, forgetting the exact balance in your account and accidentally withdrawing or charging too much. Instead of declining your card in a possibly embarrassing situation, your bank will spare you the embarrassment by making you a loan in the amount that exceeds your actual balance.

In the past, such overdrafting was not permitted by banks, and customers’ cards would simply be denied, which would let them know that their account contained insufficient funds. However, banks have created a lucrative business by allowing the overdraft and charging a fee for the service. This fee and the amount overdrafted are automatically extracted from the customer’s next deposit.

What makes overdrafting so costly is that the fee charged by banks is a flat fee applied to every overdraft, regardless of the amount. Thus, a customer exceeding his/her funds by a mere $5 could end up paying a fee of $25 or more. Estimates are that consumers pay at least $17.5 billion each year for these overdraft loans. Opponents of this banking practice are most concerned with the fact that these overdraft loans are unauthorized.¹

The unauthorized nature of these loans is worrisome for a few reasons. First, the fees charged by banks are pretty high and can really add up to an overwhelming sum for some customers, especially low-income individuals. Also, many banks charge a higher fee every time a customer overdrafts in a specific period of time, but the customer is never explicitly notified of an overdraft and could overdraft several times before realizing it. In addition, if a customer does not make a deposit soon after overdrafting to reconcile the outstanding loan and fee, some banks will charge another fee for sustained overdrafts.

Opponents of these unauthorized overdraft services find them to be in violation of the Truth in Lending Act (TILA), which was designed to keep consumers informed about the relevant information in credit transactions. Overdraft loans are actually one of the most expensive types of credit, but they are not covered under TILA.

Customers are often unaware of their participation in such overdraft loan programs because banks enroll current and new clients in these programs without their consent. Thus, they are not informed of the possible fees associated with overdrafting and cannot choose to opt out of such programs.

The reason overdrafting is becoming costlier than ever before is because banks have been increasing their fees over the years. The average highest fee charged in 2006 was $34.65, which was up 15 percent from the average of $30.30 in 2005. Also, banks are increasing the number of allowable overdrafts in one day. Bank of America used to only allow five overdrafts in a day and now allows seven.² Seven may seem like a lot but people are using plastic as a form of payment over cash more and more, so it’s not hard to imagine a day where you’d make seven purchases with a card.

Since banks are not mandated to divulge the particulars of their overdraft programs to customers, they can increase their fees without warning. Several consumer activist groups are petitioning to include overdraft programs under the Truth in Lending Act to make sure the customer is well-informed regarding fees, etc.

Until then, consumers can protect themselves by familiarizing themselves with the terms of their particular bank’s overdraft program (fees, sustained overdraft fees, etc.). After becoming familiar with it, the customer can contact their bank and ask for one of two things: 1) to be removed from the program altogether or 2) to be notified when an overdraft occurs.

Special Note

¹ Account holders typically agree to such overdraft protection as a term of the account agreement. However, this feature is not actively chosen by most applicants and generally is buried in the fine print (terms and conditions) of the account agreement. Most applicants are unaware of the feature until after they have already incurred overdraft fees.

² Most U.S. commercial banks have increased daily limits for overdraft charges. Fees charged by Bank of America are not unlike those charged by other banks.

Related Link

The Federal Reserve Board: Protecting Yourself from Overdraft and Bounced-Check Fees