Bank overdraft protection programs, at first glance, seem like a great safety net to have in place. Should you overdraw your checking account, an overdraft protection plan can kick in to cover the shortage. And because the bank cleared the check, you avoid insufficient funds fees that can hit $35 and the embarrassment and headaches that come with a returned check. Banks do charge interest on the money until you repay it, but for most, the interest charged is just for a day or two until the next payday. The problem with these programs, however, are the ridiculous and often hidden fees that banks charge. We’ll come back to the fees, but first, let’s take a look at the types of overdraft protection programs banks offer.
Overdraft Protection Plans
There are several different ways banks allow you to cover overdrafts. Each comes with different advantages and disadvantages, so it’s important to understand the differences.
Courtesy overdraft-protection, or bounce coverage, plans : Many banks offer a courtesy plan to pay a check or honor an ATM transaction even if you have insufficient funds to cover the transaction. Some banks will automatically enroll new customers in such a plan, and unless you read your mail very carefully, you may not know it.
These courtesy overdraft plans do cost money. Typically, banks charge betwen $20 and $30 per transaction. In addition, there is no guarantee under these courtesy plans that the bank will cover every overdraft.
Linked savings account: Some banks will allow customers to a link a savings account to their checking account. Should the checking account be overdrawn, the bank will automatically transfer funds from the savings account to cover the check or ATM transaction. As with the courtesy bounced check plans, banks also charge a per transaction fee for linked savings account plans.
Linked credit cards: Similar to linking a savings account, you can also link a credit card to your checking account in many instances. Banks treat these transactions like a cash advance, requiring you to pay the cash advance fee and whatever cash advance interest rate the card charges.
Overdraft line of credit: With this plan, customers apply for an unsecured line of credit designed solely to cover any checking account overdrafts. These unsecured lines typically charge double-digit interest rates, but if you pay off the line quickly (on payday, for example), then the interest charges are relatively modest. This is what we use at Citibank, and in the past, it came in handy as we neared payday. That is, until Citibank quietly began charging fees for each transaction that rival the cost of a payday loan.
Overdraft Protection Fees
Several months ago, Citibank began charging a $10 transaction fee for each check or ATM charge that required the linked line of credit to cover the transaction. If, on the day before payday, we used our ATM card four times without sufficient funds in the bank, Citibank charged us a total of $40, regardless of the amount of the overdrafts. We would pay off the overdraft line the next day when we received our direct deposit, but the $40 was already taken from our accounts.
To make matters worse, Citibank doesn’t go out of its way to warn customers of this charge. It began charging the $10 fee without reasonable notice. We spent 30 minutes on the phone with a Citibank representative who claimed that Citibank had mailed out a letter notifying its customers of the new fee. The letter either never made it to us, or was part of a dense package of junk that Citbank regularly sends out.
We’ve made some adjustments to our finances to avoid using this line of credit ever again. It’s unfortunate that banking has come to this, but Citibank is not alone in charging its customers ridiculous fees.
In fact, last December the FDIC issued a scathing study of overdraft fees charged by major banks, concluding that the costs exceed that of payday loans. Here are the highlights of the study:
- Overdraft fees have APRs ranging from 1067% to 3520%
- Banks operating automated overdraft programs reported a median transaction of $36
- Customers with 5 or more NSF transactions accrued 93.4% of the total NSF fees reported
- Young adults paid the most in overdraft fees; responsible for the most NSF transactions
- Customers in low-income areas were more likely to pay recurrent overdraft charges
- Customers were automatically enrolled in overdraft protection programs
- Banks process large debits first; making overdrafts more frequent
- Banks allow ATM and debit card overdrafts, but do not alert customers in advance
One way to avoid overdrafts in the first place is with an effective budget. I’m working on several budgeting articles that will be posted soon. Until then, it is worth checking out You Need A Budget (YNAB) software, an effective, easy to use budgeting system that comes with a 60-day money back guarantee.