Here’s a good way to conceptualize how much overdraft fees can pile up for repeat users: If a room of 100 people were asked if they had been charged two or more overdraft fees in the past 6 months, only 16 would raise their hands. However, those 16 people make up more than 70% of the total amount of overdraft fees paid. And just 6 of those people account for almost half of the total overdraft charges. So how can people stop this “debt trap” of compounding overdraft fees?
The Overdraft Fee Catch-22
The volume of comments we receive concerning overdraft fees has grown tremendously over the past year. And while unexpectedly losing out on $35 dollars once or twice is certainly annoying for anyone, for those hardest hit by overdraft fees the charges can become a very serious financial issue, sometimes resulting in over $500 in fees that can dig some people into a hole that is very hard to get out of. According to a 2006 report by the Center for Responsible Lending, the average repeat user of overdraft fees is 35-39 years old, non-white, and single, with a household income of $30,000-$35,000. Only 61% or repeat overdraft users own their own home.
These statistics emphasize one of the biggest problems with overdraft fees, in that they generally target low-income individuals, who are riding the edge of their balances, living paycheck to paycheck and often having very little cash on hand in their accounts. For these customers, overdrawing their account is not so much a mistake that results in penalty or reminder, but instead a type of high-cost line of credit. This is especially true for people who cannot qualify for credit cards, who instead use the ability to go over their accounts as a form of credit, while in reality they are simply putting themselves further and further into overdraft debt.
The problem with this is that with fixed rate overdraft fees, a loan given to the bank for an overdraft of quadruple-digit interest rates. For example, a $35 fee for an $10 overdraft loan translates into a 4,217% APR if the overdraft is repaid in a month. Traditional lines of credit, on the other hand, have annual interest rates of 11% to 19%. For the same one month, $10 loan, the interest expense with a line of credit would be only $0.16.
|Overdraft Fee||Traditional Line of Credit|
Many banks, in response to the public outcry over such fees, have recently scaled back the rates and the number of times per day that they will charge overdraft fees. Some have gone further, allowing customers the option of getting rid of the service all-together, and simply deny your card when your account does not have sufficient funds to cover your purchase or withdrawal. Legislation that will go into effect February of 2010 will require banks to provide customers with the option to “opt-out” when opening new accounts.
However, there is still a catch here. While you will no longer be charged overdraft fees, banks still hold the right to charge non-sufficient fund (NSF) fees, more commonly known as “bounced check” fees, if you debit more than you have available in your account. These can sometimes be more expensive than overdraft fees, and can also mean that the transaction which overdraws your account will be denied, unlike overdraft, which allows it to go through.
Some Possible Solutions
For the common repeat user, this change simply stops them from being able to use their debit card as a line of credit while still compiling fees they cannot afford. After reviewing the many possible options, as well as the complaints from hundreds of consumers, it seems that a system which denies users the ability to go over their spending limit is the logical solution. Banks could simply decline a debit card transaction that will put the balance in the negative, just like they do with credit cards that has been charged over their credit limit. No bounced check fees, no overdraft fees, and no purchase processed for the consumer. Instead, debit cards would be following the basic principle that if there is no money in the account, the account can no longer be used for purchases.
Another possibility is to develop a system that would alert customers that a fee will be assessed, and allow them to decide if they would like to proceed with or decline the transaction. This would take banks off the hook by making it clear to the customer what they are agreeing to, but still provide the service for those who want it. Being faced with this decision at the point of transaction, rather than retroactively when they receive their monthly statements, might cause consumers with bad budgeting habits to remember that if they do not have the money for something, it could be a better idea to not buy it at all. It seems to us that implementing a policy on overdrafts that provides a gentle form of financial education, rather than one which has the potential to cause large financial problems for consumers, could be a better options in the long run for both banks and consumers.
Have you had problems with overdraft fees? Do you think these solutions might work? We’re interested in what you have to say; let us know what you think by completing the survey below, and see how your answers compare to those of our other users. Or, email us your suggestions at firstname.lastname@example.org.