Many banks actively encourage their clients with low balances to overdraw
their accounts. That means, if the customer writes a check or uses her debit
card and has insufficient funds in the account, the bank clears the check by
granting a temporary overdraft (a short-term loan), up to a specific limit. The
customer is saved from the problems of bounced checks or interrupted shopping
sprees.
Sounds like a good deal for the customers, right? That's what the banks say.
They claim overdrafts are an added convenience to customers.
The truth is, they're often a very bad deal for the customers. Here's why.
When a bank grants a regular line of credit, the interest charged may be up
to say, 20% or so. However, for overdrafts, banks don't charge interest -- they
charge a flat fee on each transaction. This fee does not depend on the value of
the transaction.
Let's see how that works. Overdraft plans fees may be as high as $35 per
check. We'll assume a more conservative fee of $20 per check. If you have four
checks totaling $200 that have insufficient funds against them and the bank
automatically activates the overdraft and clears those checks, you will owe $80
in overdraft charges.
Unlike revolving lines of credit which you can repay at your convenience, an
overdraft has to be settled in just a few days. Let's say the bank allows you to
run the overdraft for 14 days.
A loan of $200 for 14 days incurring charges of $80 translates into an Annual
Percentage Rate (APR) of 1043%!
A "convenience" for customers? Not at these rates.
What does this remind you of? It reminds me of payday loans and cash
advances. Those are the other forms of lending which charge you such sky-high
APRs. In fact, if you choose to repay a cash advance on due date and not roll it
over, you'll likely be charged far less than what the banks charge you for an
overdraft.
It gets even worse. Banks have software that ensures that your largest value
checks and debits get processed first. There may be some logic to that. However,
this arrangement also means that when there are insufficient funds in your
account, instead of paying one overdraft charge on one large check, you pay
several charges on several smaller checks!
Plus, most customers don't even realize that they are overdrawn until the
bank notifies them about it.
Consumer advocates say that banks are perfectly aware that many people barely
make it from payday to payday. These customers typically have very low balances.
Rather than offer them a service that would be in their interests, banks extract
high fees from them to cover bounced checks.
If you are caught short between paychecks, consider arranging funds from
other sources rather than turn to overdraft protection. The best solution to the
problem is to systematically build up cash balances so that you don't face such
a situation in the first place.
