"At Sovereign, we know our customers don't need the hassle and potential embarrassment of having a debit card purchase or ATM withdrawal denied due to insufficient funds," says Sovereign Bank's site. "It only takes a moment to stay protected," says SunTrust. "Don't lose the convenience of this important feature. Talk to a banker today," urges Chase. You may have seen similar messages on your bank's website, ATM screens, in branches, and in your account statements.
What's all the hubbub? New Federal Reserve rules go into effect tomorrow that require banks to get new customers' permission before enrolling them in debit overdraft protection plans (existing customers must also opt-in but the effective date for them is Aug. 15). Before these rules, your bank likely enrolled you (without giving you any notice) in an overdraft protection plan that covers check, ATM, and debit card transactions that exceed your checking account balance. Sounds great - except that for each overdraft you'd be hit with an exorbitant fee.
Overdraft programs are really high-cost, short-term loans with quadruple-digit APRs. Most banks charge flat overdraft fees. So if your balance goes to zero purchasing even a $1 pack of gum with your debit card could trigger a fee of $35 or more. Once you've exceeded your balance, every purchase you make could generate another fee. And, some banks still impose long hold times before you can use the money from checks you deposit, which increases the possibility that you will overdraw your account.
In addition, many banks process transactions from the highest to the lowest amount, which depletes customers' accounts more quickly and triggers more overdrafts. Some customers have complained they didn't know about the service until they got the bill.
The new deal
Though the messages on the bank websites, ATMs, and in your statements couch overdraft protection plans in terms of your convenience, by opting in - either in a new account or with your existing one - you're giving the banks permission to gouge you if you overdraw your account. Do nothing, and ATM withdrawals or debit-card transactions for more than the amount you have in your account will simply be rejected and no fee will be assessed. "Consumers should just say no to these astronomical fees," says Jean Ann Fox, director of financial services for Consumer Federation of America, which released a report yesterday that shows overdraft fees and how they translate into APRs for the largest 15 banks that charge them.
Unfortunately, the law does not cover overdrawn checks or automatic payment programs used for recurring bills, such as rent, mortgage payments, or utilities. And the Fed rule doesn't limit the size of fees banks can charge, which means consumers who sign up for overdraft services could still owe a bundle on small overdrafts. Consumer's Union, the nonprofit publisher of this blog, offers more information on overdraft fees on its blog, Defend Your Dollars. Cheaper ways to cover overdrafts Overdraft fees generate billions in revenue for banks each year, which explains the urgency of those messages you see. But there are other less-costly ways to avoid having your debit card rejected at the register, including:
- Link your checking account to a savings account. If you overdraw your checking account, money in your savings account is used to cover the transaction. Banks typically charge a fee to transfer the money, but it's usually just $5 to $10—much lower than the fee charged by overdraft programs.
- Set up low-balance alerts. Many financial institutions will send you an e-mail or text when your balance reaches the danger zone.
- Sign up for online banking. Regularly monitoring your checking account online will help you avoid spending money you don't have.
- Get an overdraft line of credit with your bank or credit union. You'll need to apply, and customers with poor credit may not qualify. But if you're eligible, this could provide a less expensive form of overdraft protection than fee-based coverage.
