At one time or another, you may have had the misfortune of over-drafting your bank account. An overdraft occurs when you make a purchase or ATM transaction but don’t have enough money in your bank account to cover it. For a fee, anywhere between $25 and $35, your bank will cover the transaction. That’s a pretty high price, and one that can be triggered several times a day if you attempt to make multiple transactions with an insufficient balance. In July 2010, the Federal Reserve implemented rules that were supposed to reduce the number and severity of bank overdrafts. However, two years later, not much has changed. In fact, things may be getting worse.
Overdrafts are big business to banks. In 2002, overdrafts generated $23 billion in revenue. That’s a significant percentage of bank profits. In 2009, overdraft fee revenue hit an all-time high of $37.1 billion. Fast forward to 2011, when banks pocketed $31.6 billion in fees, begging the question, just how much of an impact did the 2010 Federal Reserve’s intervention have? Of particular interest to consumer activists is the fact that just 9% of checking account customers generated 84% of 2011’s overdraft revenues.
One of the Fed’s 2010 rule changes was that banks could no longer automatically enroll people in overdraft protection plans. Consumers now have to opt-in to such coverage, a change that was intended to drive down the costs of such services. And yet overdraft fees went up, not down. That attracted the attention of the new Consumer Financial Protection Bureau. The CFPB is reviewing why these fees have not subsided, and whether the industry average, roughly $30, is appropriate. Several organizations have assembled focus groups to determine the staying power of overdraft fees, and some of their findings are alarming. According to the Pew Charitable Trusts and the Center for Responsible Lending, many bank customers thought they had opted out of overdraft fees, when they had actually done the opposite. Furthermore, some consumers believed that choosing the bank’s “protection” means that they wouldn’t be charged an overdraft fee, whereas the reverse is true. This miscommunication is attributed to poorly written marketing material describing the opt-in process and, presumably, positioning overdraft protection as a necessity for debit card transactions.
There are several things you can do to avoid overdraft fees, chief among them is becoming more financially literate. It’s no secret that we are not the most financially savvy society. Many of us, and I mean MANY, do not take the time to read and comprehend the terms and conditions of the contracts we enter. Well, ignorance may be bliss, but it’s also costly. Fortunately, there are plenty of ways you can stop paying for what you don’t know. You can purchase a personal finance book, read some of the hundreds of financial blogs on the internet, or contact a non-profit credit counseling agency, which can help educate you on variety of financial topics. Next, don’t rely on your bank’s posted available balance. Many financial institutions cannot account for transactions that come in after the end of the business day, or checks. The result is a temporary difference in what they represent as your currently available funds. Next, you can, and should, balance your checkbook. This can help you track your actual balance and avoid overdraft charges. Finally, opt-out of overdraft protection. Sure, some of your purchases may be declined, but you can save a tremendous amount on fees. Nobody wants to pay $35 for a sandwich, which is what can happen if you overdraw your account, even by a few dollars.
It’s difficult to say what will come of the review of overdraft practices. As we’ve seen, regulatory intervention can be an exercise in unintended consequences. We experienced the same increase in fee revenues due to the CARD Act of 2009, when banks began to do away with free checking accounts. It’s easy to say that government intervention is needed to curtail unnecessary fees, but the truth is the best protection is knowledge, and that knowledge is easy to come by with a little effort. Until next time, I’m Thomas Fox for Cambridge Credit Counseling.