Earlier this year, the Fed called banks on their excessive overdraft fees, and now requires them to ask customers to opt-in to this “service,” rather than providing it by default. Overdraft fees, for those of you who have never incurred them, are the fees a bank charges you when you try to withdraw more money than you have in your account. They essentially extend you credit to cover your withdrawal, but charge you a hefty fee for the privilege. The program that allows them to extend credit and charge fees is called overdraft protection.
Why are Customers Opting In?
Based on what their CEOs are saying, banks are somehow convincing around half of their customers to opt-in to overdraft protection. An FDIC study shows that the 5% of people most affected by overdraft fees get fined over $1,610 per year on average. But now, just the illusion of choice rather than involuntary fees has gotten a number of their customers back on board.
Why are Customers Opting In?
As you can imagine, there are plenty of angry customers and class action lawsuits. An FDIC study shows that the 5% of people most affected by overdraft fees get fined over $1,610 per year on average. But now, just the illusion of choice rather than involuntary fees has gotten a number of their customers back on board. After ending overdraft protection earlier this year, BofA has reported seeing account closure rates drop 27%! Of course, the fees aren’t gone completely... they still might pop up at the ATM.
A $35 ATM Overdraft Fee Is More Expensive Than a Payday Loan
If this call is any indication, banks will continue letting customers overdraw their hearts out on checks, ACH (electronic checking) transfers, and at the ATM. However, with ATM transactions, they will have to ask if you’d like to pay the $25 to $35 fee before they allow the transaction.
Here’s where it gets interesting: A shady payday loan for $100 typically costs customers about $15 for two weeks of breathing room, an effective annual rate of 3.785%. The rate for a $35 overdraft fee on $100 is more than double that rate.
Our advice is to avoid both. If all you need is some breathing room, a balance transfer credit card is probably a better option, since some these days are offering effective annual rates of 3% over two years. And if that’s too much, any credit card will still give you a month of free float to get you to that next pay check. Just be careful not to overdo it, because you won’t get that ATM overdraft warning when you swipe a credit card.
Overdraft Protection Makes Your Debit Card Into a More Expensive Credit Card
We realize there are some situations where it’s better to pay a $35 overdraft fee than to have your transaction denied, like if you are completely out of gas on your way to work. However, even in that scenario you’re probably not going to get approved for the overdraft unless the bank believes you can pay them back. Overdraft is not really a service, but a loan.
In that case, you have to evaluate this option against other credit products, and a credit card in your wallet for exactly such an emergency turns out to be the better option, contrary to popular belief. Even if you have no credit or bad credit, a secured credit card would serve the purpose in the meantime. So opt out, and save yourself some money.